City of Miami Fire Fighters' & Police Officers' Ret. Trust v. Quality Sys., Inc. (In re Quality Sys., Inc. Sec. Litig.)

• Citation: 865 F.3d 1130
• Decision Date: 28 July 2017
• Docket Number: No. 15-55173,15-55173
• Parties: IN RE QUALITY SYSTEMS, INC. SECURITIES LITIGATION, Debtor. City of Miami Fire Fighters' and Police Officers' Retirement Trust ; Arkansas Teacher Retirement System, Plaintiffs-Appellants, v. Quality Systems, Inc.; Steven T. Plochocki; Paul A. Holt; Sheldon Razin, Defendants-Appellees.
• Court: United States Courts of Appeals. United States Court of Appeals (9th Circuit)

865 F.3d 1130

IN RE QUALITY SYSTEMS, INC. SECURITIES LITIGATION, Debtor.

City of Miami Fire Fighters' and Police Officers' Retirement Trust ; Arkansas Teacher Retirement System, Plaintiffs-Appellants,

v.Quality Systems, Inc.; Steven T. Plochocki; Paul A. Holt; Sheldon Razin, Defendants-Appellees.

No. 15-55173

United States Court of Appeals, Ninth Circuit.

Argued and Submitted December 5, 2016 Pasadena, California

Filed July 28, 2017

Joseph D. Daley (argued), Christopher D. Stewart, and Robert R. Henssler, Jr., Robbins Geller Rudman & Dowd LLP, San Diego, California; Benjamin Galdston, Blair A. Nicholas, Brandon Marsh, and Lucas E. Gilmore, Bernstein Litowitz Berger & Grossmann LLP, San Diego, California; Avi Josefson and Gerald Silk, Bernstein Litowitz Berger & Grossman LLP, New York, New York; Stephen H. Cypen, Cypen & Cypen, Miami Beach, Florida; for Plaintiffs-Appellants.

Peter A. Wald (argued), Latham & Watkins, San Francisco, California; Andrew R. Gray and Michele D. Johnson, Latham & Watkins LLP, Costa Mesa, California; Colleen C. Smith, Latham & Watkins LLP, San Diego, California; for Defendants-Appellees.

Before: Stephen Reinhardt, William A. Fletcher, and Richard A. Paez, Circuit Judges.

OPINION

W. FLETCHER, Circuit Judge:

Lead Plaintiffs City of Miami Fire Fighters' and Police Officers' Retirement Trust and Arkansas Teacher Retirement System brought this would-be class action on behalf of all persons or entities who purchased or otherwise acquired the common stock of Quality Systems, Inc. ("QSI") between May 26, 2011, and July 25, 2012 ("the Class Period"). Plaintiffs allege that during the Class Period defendant QSI and several of its officers ("Defendants") made false or misleading statements about the current and past state of QSI's sales "pipeline," and used those statements to support public guidance to investors about QSI's projected growth and revenue. Individual defendants are Sheldon Razin, QSI's founder and Chairman of the Board; Steven Plochocki, QSI's Chief Executive Officer ("CEO"); and Paul Holt, QSI's Chief Financial Officer ("CFO"). Plaintiffs allege that the individual defendants had real-time sales information showing a decline in sales due to market saturation beginning as early as April 2011, and that individual defendants knew that their public statements denying any decline were false or misleading.

The district court dismissed Plaintiffs' complaint with prejudice, finding that Defendants' non-forward-looking statements about the past and current state of QSI's sales pipeline were non-actionable puffery, and that their forward-looking statements about projected growth and revenue were protected by the safe harbor provision of the Private Securities Litigation Reform Act, 15 U.S.C. § 78u-5. We reverse and remand for further proceedings.

I. Background

QSI is a California corporation that "develops and markets practice management and electronic health records (‘EHR’) software to medical and dental care providers." QSI was founded in 1974 by defendant Sheldon Razin, who was President and CEO until 2000. QSI benefited significantly from the passage of the 2009 American Recovery and Reinvestment Act, which provided $60 billion in incentives for healthcare providers to convert from paper to electronic records. During the Class Period, QSI's stock price largely depended on investors' belief that its revenues were growing rapidly. QSI's growth largely depended, in turn, on sales and maintenance of new software systems for healthcare providers, which "included software, hardware, third-party software, supplies and implementation and training services components." New system sales were particularly important because they "included the promise of future, high-margin maintenance revenue." During QSI's Fiscal Year 2012 (April 2011 through March 2012), over 66 percent of QSI's total revenues came from sales and maintenance of such new software systems.

QSI's largest division, NextGen, develops and sells software systems for medical offices. During FY 2012, NextGen accounted for 75 percent of QSI's total revenue. During that same period, NextGen accounted for 83 percent of QSI's revenue from software systems sales and 84 percent of its revenue from software systems maintenance.

QSI's primary source of growth was sales of software systems to healthcare providers who were adopting electronic healthcare systems for the first time, referred to as "greenfield" sales. QSI's most profitable source of revenue was new practice management and electronic health records software. Sales and maintenance of this software had gross margins of 75.7 percent and 61.6 percent, respectively.

During the Class Period, QSI kept continuous track, in real time, of its sales "pipeline." The pipeline comprised four categories. Category 1 included deals that were expected, with 70 percent certainty, to close within three to four months. Category 2 included deals that were expected, with 70 percent certainty, to close within six to eight months. Categories 3 and 4 included deals that were not expected to close within eight months.

The gravamen of Plaintiffs' suit is that the individual defendants knew during the Class Period that the market for healthcare software systems was becoming increasingly saturated, and that greenfield sales opportunities were decreasing. The complaint alleges that from late 2011 through mid-2012 (roughly, from the beginning of the second half of FY 2012 through the first quarter of FY 2013), Defendants misrepresented the state of QSI's current and past sales pipeline and used the misrepresentations to support projections of growth in revenue and earnings. The complaint alleges that QSI's projected growth "lacked any objective basis and ... [was] totally inconsistent with QSI's actual business performance." (Quotation marks omitted).

On July 26, 2012, QSI issued a press release finally admitting publicly that the company's business was in steep decline. As a result of this announcement, QSI stock prices dropped precipitously, causing Plaintiffs significant losses.

A. False or Misleading Statements

The following narrative is taken from Plaintiffs' amended complaint. We take as true the complaint's plausible and properly pleaded allegations, which we recount below. Zucco Partners, LLC v. Digimarc Corp. , 552 F.3d 981, 989 (9th Cir. 2009).

The complaint alleges that on a number of occasions Defendants, particularly CEO Plochocki, made false or misleading statements of current and past facts, as well as false or misleading statements of projected growth in revenue and earnings per share.

On June 9, 2011, at a Goldman Sachs Global Healthcare Conference, CFO Holt stated that the market for QSI's products in ambulatory health care facilities was "greenfield for the most part" and that he thought "it's going to be that way for a while."

On October 27, 2011, QSI held an analyst conference call. When asked whether the electronic health records market was becoming saturated, Plochocki responded that "the greenfield opportunities are plentiful. [M]ore than half the large practice market, more than 75% of the midsize practice market is still fair game for new system sales." During that call, Plochocki predicted a "revenue range of growth of 21% to 24% for the year and an EPS [earnings per share] growth of 29% to 33% for the year."

On November 7, 2011, Investor's Business Daily published an interview with Plochocki entitled "Quality Systems Chief Says Boom Just Getting Started." Plochocki was quoted as saying, "There is nothing drying up and there is nothing slowing down."

On December 14, 2011, Plochocki participated in an Oppenheimer & Company, Inc., Healthcare Conference. At that conference, he stated, "So the bottom line is that our pipeline current and our pipeline future are very robust." In response to a comment that large and mid-size medical practices may be totally penetrated, Plochocki stated, "You wouldn't know that by our pipeline and you certainly would not know that by our categories three and four in our pipeline."

On January 9, 2012, at a J.P. Morgan Healthcare Conference, Plochocki stated that QSI had "given analysts prognostications for ... earnings per share growth [in the] 29% to 34% range."

On January 26, 2012, in a conference call with analysts, Plochocki stated, "Our pipeline continues to build to record levels." In that same conference call, after stating that he had access to current internal data, NextGen President Scott Decker stated, "[W]e haven't changed any of the model in our reporting pipeline, so it's very consistent, and there's nothing out of character in the pipeline that we're reporting today versus what we have seen there the past couple of years."

On February 7, 2012, Plochocki participated in a UBS Global Healthcare Services Conference. At that conference, he stated, "[W]e have $183 million worth of pipeline, the business we intend to close within the next six to eight months. That sales pipeline has grown every quarter since the announcement of the stimulus bill back in February of 2009 and we view it as continually growing[.]"

On May 7, 2012, Plochocki participated in a Deutsche Bank Healthcare Conference. At that conference, he stated that he had access to up-to-the-minute sales information that showed that "[t]he deals are elongated." "[T]he deals are taking a little bit longer to get done." On May 8, J.P Morgan characterized Plochocki's commentary as "downbeat."

On May 9, 2012, in response to J.P. Morgan's negative characterization, Decker appeared before investors at a Robert W. Baird & Co. Growth Stock Conference. In response to a question about Plochocki's statement two days earlier, Decker said, "[S]ome comments earlier this week at another conference were made ... that [the sales cycle] may be lengthening.... [I]t is absolutely not a macro trend we are seeing. In fact, I went back through the data over the last few days and objectively looked at it. Sales cycle has not lengthened for us...