Hill v. Gozani

• Decision Date: 18 March 2011
• Docket Number: No. 10–1048.,10–1048.
• Citation: 638 F.3d 40
• Parties: Gordon L. HILL; NECA–IBEW Pension Fund; Southwest Carpenters Pension Trust, Plaintiffs,Anima S.G.R.P.A., Plaintiff, Appellant,v.Shai N. GOZANI; W. Bradford Smith; Gary Gregory; NeuroMetrix, Inc., Defendants, Appellees.
• Court: U.S. Court of Appeals — First Circuit

638 F.3d 40

Gordon L. HILL; NECA–IBEW Pension Fund; Southwest Carpenters Pension Trust, Plaintiffs,Anima S.G.R.P.A., Plaintiff, Appellant,

v.Shai N. GOZANI; W. Bradford Smith; Gary Gregory; NeuroMetrix, Inc., Defendants, Appellees.

No. 10–1048.

United States Court of Appeals, First Circuit.

Heard Sept. 15, 2010.Decided March 18, 2011.

Benjamin J. Sweet, with whom Michael Yarnoff, Lauren Wagner Pederson, Richard A. Russo, Jr., Barroway Topaz Kessler Meltzer & Check LLP, David Pastor, and Gilman & Pastor LLP were on brief, for appellant.Deborah S. Birnbach, with whom Kevin P. Martin, Lauren Stock Craven, and Goodwin Procter LLP were on brief, for appellees.Before BOUDIN, RIPPLE,^* and SELYA, Circuit Judges.RIPPLE, Circuit Judge.

The NECA–IBEW Pension Fund, a shareholder in NeuroMetrix, Inc., instituted this action against NeuroMetrix and three of its officers, alleging securities fraud in violation of sections 10(b)(5) and 20(a) of the Securities Exchange Act, 15 U.S.C. §§ 78j(b) and 78t(a). On the plaintiff's motion, the case was consolidated with several other pending shareholder suits against NeuroMetrix. The district court designated Anima S.G.R.P.A. as lead plaintiff for the class of shareholders during the period of October 27, 2005, through March 6, 2007.

In the consolidated action, the defendants moved to dismiss the complaint for failure to state a claim under Federal Rule of Civil Procedure 12(b)(6), as well as under the additional pleading requirements of Rule 9(b), applicable to fraud claims. The district court granted the motion, concluding that the plaintiffs had failed to identify actionable misstatements under the securities laws. The plaintiffs now appeal.

Because the district court correctly analyzed the allegations of the complaint and correctly concluded that, in light of the applicable legal standards, it contained no actionable misstatements, we affirm the judgment of the district court.

IBACKGROUND

A. Facts

The complaint alleges a scheme in which NeuroMetrix manufactured a medical device that vastly simplified an existing medical procedure. In marketing the device to physicians for use in their offices, NeuroMetrix represented that procedures performed could be billed using existing standardized codes when seeking reimbursement from insurers, including Medicare. These codes had been created to reimburse for the older, specialist-driven, invasive procedure. Use of the “neurology codes” thus resulted in reimbursement at artificially high rates for a procedure performed with NeuroMetrix's device. According to the shareholders, NeuroMetrix knew that its scheme would be discovered shortly and that, as profit margins to physicians' offices fell dramatically, the market value of the device also would plummet. A decrease in revenue and a collapse of stock value would follow. The complaint alleges that NeuroMetrix misled investors into underestimating the risk of this fall in value, while individual officers, with knowledge of the real risk, divested themselves of significant amounts of stock at great personal profit. Federal civil and criminal investigations followed, and the shareholders thereafter brought this action.

Because this case was dismissed for failure to state a claim upon which relief could be granted, we recount the facts as set forth in the complaint in significant detail.

1. The NC–Stat

NeuroMetrix manufactured and marketed a signature product during the class period, a machine called the NC–Stat. The NC–Stat is a device that permits non-invasive nerve conduction studies to “detect[ ], diagnos[e], and monitor [ ] neurological conditions affecting the peripheral nerves.” R.32 at 2. The NC–Stat “is comprised of a battery-operated hand-held device and disposable single-use biosensors that are placed on the patient's body ... to detect neuropathies.” Id. at 11. The device was marketed “to provide primary care and specialist physicians with the ability to rapidly diagnose neuropathies in the physician's office at the time the patient is examined.” Id. at 12. Prior to the introduction of the NC–Stat, the prevailing standard technology for neurological studies for these conditions was electromyography (“EMG”), an invasive, needle-based test performed by neurologists.

The NC–Stat sold for about $5,000 and the disposable biosensors for roughly $35 a piece. The bulk of the profit to NeuroMetrix came through the sale of the biosensors. The device was marketed as providing non-specializing physicians, who traditionally could not perform diagnostic tests in this field, with a sustainable source of revenue.

2. Billing Codes and Insurance Reimbursement

The ability of physicians to profit from the use of any medical equipment device—a significant factor in the device's market value—depends largely upon reimbursement rates from insurers. Medical reimbursement across insurers begins with a physician's bill to an insurer under a standardized system, which uses five-digit, procedure-specific identifiers, called Current Procedural Terminology (“CPT”) codes. CPT codes are assigned by the American Medical Association (“AMA”). A number of “relative value units” (“RVUs”) is then recommended for each coded procedure. RVUs attempt to account for the work performed by a physician, the physician's training and expertise, the type of equipment used and the professional liability insurance required to perform a particular coded service. Insurers, including Medicare, assign a physician fee schedule based on a dollar-amount multiplier per approved RVU.¹ In short, in selecting a CPT code to bill for a particular procedure, a physician effectively knows of a determinative reimbursement rate for that procedure from each insurer during a given fiscal year. As part of fraud detection efforts, when use of a particular code increases by 10% or more during a given year, Medicare “is alerted and usually commences an investigation.” Id. at 17.

When the NC–Stat was introduced to the market, it did not have a specific CPT code assigned to it. Instead, according to the allegations of the complaint, NeuroMetrix instructed its sales personnel to “actively promote” the use of existing, neurology-based CPT codes to seek reimbursement for the NC–Stat procedure. Id. at 14; see also id. at 15–16. According to a confidential NeuroMetrix employee witness, the recommended codes

were originally value weighted for neurologists to detect and diagnose neuropathies through combined use of invasive EMG needle tests and conventional nerve conduction studies involving highly calibrated multi-million dollar equipment.... Thus, under the RVUs assigned to the nerve conduction CPT billing codes, a neurologist could make between $700 and $900 per exam, ... because an expensive calibrated machine is utilized. In short, according to [the confidential witness], the expensive equipment used by a neurologist is one of the key factors in determining that the neurology-based CPT codes (95903 and 95904) reimburse at significantly higher dollar amounts than simple, automated procedures such as the NC–Stat System.

Id. at 15 (emphasis in original).3. Internal Billing Discussions and Recommendations

The complaint further alleges that NeuroMetrix, through its officers, knew that the billing practices it advised physicians to adopt were unsustainable.² It employed two separate directors of reimbursement with more than fifty years of collective CPT coding experience. Both of these experts advised Shai Gozani, President and Chief Executive Officer, and Gary Gregory, Chief Operating Officer, that they could not promote the use of the neurology-based codes in marketing the NC–Stat. The first such director advised the executives that NeuroMetrix should instruct physicians to use miscellaneous codes in the short term, which would, “at best, pay one-third or one-fourth of what the existing neurology-based CPT codes paid to physicians.” Id. at 16. The director advised that, in the longer term, the company needed to apply to the AMA for a new code for the NC–Stat procedure and, in advance of such application, that NeuroMetrix should obtain certain peer-reviewed articles about the efficacy of the device. Mr. Gregory asked the director what amount physicians would be reimbursed in the interim, and was told “ ‘close to nothing’ until the AMA ‘validated’ ” the device. Id. According to the director, Mr. Gozani and Mr. Gregory hoped instead to “ ‘fly under the radar,’ ” and Mr. Gregory specifically stated that the company “ ‘could not afford to tell physicians,’ ” who were “ ‘making $250 a test’ ” that “ ‘they would possibly get nothing.’ ” Id. The director informed the executives that such course of proceeding was impossible due to the 10% rule, under which the increased use of the neurology codes was likely to spark a Medicare investigation. The director informed them that Medicare knows which physicians—primary care or neurologists—are seeking reimbursement, because physicians also have a specific identification number included in reimbursement requests. The director advised that recommending the use of improper codes would be Medicare fraud. This first director resigned after the company refused to change its policy. The company's second director of reimbursement, Jan Foote, also advised the company to apply for a new, device-specific code for the NC–Stat. She told an employee that Mr. Gregory and Mr. Gozani “wanted to wait until problems with the AMA actually materialized before making any changes.” Id. at 18. She also resigned “out of frustration.” Id.

According to the complaint, sales and customer service staff confirm that they were instructed to recommend the neurology billing codes to customers. NeuroMetrix

used actual reimbursement payment receipts from other offices as verification of reimbursement under the recommended codes. Specifically, if a physician was skeptical about the precise amount of expected insurance reimbursement it would...