Gross v. Medaphis Corp.
| Decision Date | 27 May 1997 |
| Docket Number | Civ. A. No. 1:96-CV-2088-FMH. |
| Citation | 977 F.Supp. 1463 |
| Parties | Kenneth W. GROSS, PBHG Growth Fund, Charles S. Grobe, Carley Capital Group, WME Management Group, L.P., Catherine Baker Knoll, Vicki Mann, Raymond E. Smith, Deborah J. Smith, Leonard C. Mead, Jr., Dennis McDowell, and Deborah Ann Smith, Pennsylvania Public School Board Employees' Retirement Board, Plaintiffs, v. MEDAPHIS CORPORATION, Randolph G. Brown, Michael R. Cote, and James S. Douglass, Defendants. |
| Court | U.S. District Court — Northern District of Georgia |
W. Pitts Carr, Carr, Tabb & Pope, Atlanta, GA, Martin D. Chitwood, Chitwood & Harley, Atlanta, GA, Richard H. Weiss, David H. Bershad, Steven G. Schulman, Janine Pollack, Milberg, Weiss, Bershad, Hynes & Lerach, New York City, Robert Roseman, Jeffrey L. Kodroff, Mark J. Dorval, Spector & Roseman, Philadelphia, PA, Jeffrey S. Nobel, Schatz & Nobel, Hartford, CT, Sherrie R. Savett & Genna D. Kidd, Berger & Montague, Philadelphia, PA, Leonard Barrack & Anthony Bolognese, Barrack, Rodos & Bacine, Philadelphia, PA, Charles Wilson DuBose, Schnader, Harrison, Segal & Lewis, Atlanta, GA, for plaintiffs.
M. Robert Thornton, Robert Riles Ambler, Jr., Jeffrey S. Cashdan, King & Spalding, Atlanta, GA, for defendants.
Plaintiffs bring this action against Defendants Medaphis Corporation and its former officers Randolph Brown, Michael Cote. and James Douglass for violations of the Securities Act of 1933 and the Securities Exchange Act of 1934.1 This matter is before the Court on Defendants' Motion to Dismiss [56-1] Plaintiffs' Consolidated Second Amended Class Action Complaint. The Court stayed all discovery pending resolution of Defendants' Motion to Dismiss.
For purposes of Defendants' Motion to Dismiss, the Eleventh Circuit instructs that the Court should accept the allegations in Plaintiffs' Amended Complaint as true and construe those allegations in a light most favorable to Plaintiffs, Bank v. Pitt, 928 F.2d 1108, 1109 (11th Cir.1991); that the Court should ignore any allegations which contain no more than opinions or legal conclusions, South Florida Water Management Dist. v. Montalvo, 84 F.3d 402, 409 n. 10 (11th Cir. 1996); and, that the Court may grant Defendants' Motion to Dismiss only if it appears beyond doubt that Plaintiffs can prove no set of facts which would entitle them to relief. Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 101-02, 2 L.Ed.2d 80 (1957); Milburn v. United States, 734 F.2d 762, 765 (11th Cir. 1984). Thus, the Court first summarizes Plaintiffs' version of the facts alleged in the 86 page Consolidated Second Amended Class Action Complaint.
Plaintiffs purchased or otherwise acquired Medaphis common stock between February 6, 1996 and October 21, 1996. Amended Complaint ("AC"), ¶ 1. Defendant Medaphis Corporation ("Medaphis") sells outsourced business management services and systems to doctors and hospitals, primarily for the management of billing and accounts receivable. Id. ¶ 2. Medaphis pursued an aggressive growth strategy through acquisitions of more than 40 companies. Id. Medaphis used primarily its common stock as currency in its acquisitions. Id. Plaintiffs allege that Defendants' scheme was to keep the value of its stock high because the higher the value of its stock, the less shares Medaphis had to transfer to effectuate each of its acquisitions. Id. ¶¶ 94, 103.
Defendants inundated the marketplace with glowing descriptions of Medaphis's past and current financial and business successes. Id. ¶ 97. As outlined below, Plaintiffs allege that Defendants wilfully concealed and knowingly misrepresented, inter alia, (a) the financial condition of Medaphis, (b) the state of affairs of Medaphis's projects, and (c) the severe operational problems experienced by Medaphis and its subsidiaries. Id. ¶ 55.
According to Plaintiffs, Defendants realized that to maintain Medaphis's high stock price, Medaphis must meet earnings estimates made by Medaphis and private securities analysts. Id. ¶ 6. Defendants falsely reported inflated earnings estimates to keep its stock prices high, and then later admitted that its earlier earnings estimates were incorrect. Id. ¶¶ 6, 9-16, 45.
Specifically, on February 6, 1996, Defendants issued a press release announcing Medaphis's fourth quarter 1995 earnings of $11.4 million, or $0.22 per share. Id. ¶ 50. The earnings resulted in a profit of $4 million and represented a 50% increase over earnings in the fourth quarter of 1994. Id. For 1995, Medaphis reported total earnings of $41.9 million, or $0.82 per share, which represented an increase of 80% over earnings for 1994. Id.
Defendants allegedly knew that Medaphis's reported earnings for the fourth quarter of 1995 were inflated by at least $5 million because Defendants knowingly employed improper and deceptive accounting principles in arriving at that result. Id. ¶ 55. Under Generally Accepted Accounting Principles ("GAAP"), a "profit is deemed realized when a sale in the ordinary course of business is effected, unless the circumstances are such that the collection of the sale price is not reasonably assured." Id. (quoting Accounting Research Bulletin (`ARB') 43, Ch. 1, § A (emphasis supplied)). "Revenues and gains are realizable when related assets received or held are readily convertible to known amounts of cash or claims to cash." Financial Accounting Standards Board ("FASB") Statement of Concepts ("CON"), ¶ 83(a) (emphasis supplied).
In reporting the fourth quarter and year end for 1995, Medaphis included revenue from software licences issued by Imonics during the fourth quarter. Id. Medaphis aggressively enlisted major customers, and included revenue from these contracts in its fourth quarter earnings, only to provide these customers with secret side letters relieving them of their obligations under their agreements. Id. Plaintiffs allege that Defendants knowingly and falsely inflated its revenues by over $5 million from these agreements. Id. In October 1996, Medaphis reported that instead of a $4 million profit, it took a $1.1 million loss for the fourth quarter of 1995. Id.
Plaintiffs also allege that Medaphis knowingly and deceptively reported inflated revenues of $12.5 million for the first quarter of 1996 from a joint venture with a subsidiary of Bertelsmann, AG, a German corporation. Id. ¶¶ 8, 82-84. The "Joint Venture" was formed to pursue custom software development and systems integration projects from customer service systems in Europe over a multi-year period. Id. ¶ 82.
On March 31, 1996, the last day of the first quarter of 1996, the Joint Venture concluded an agreement with a German telecommunications entity to provide systems integration and work flow engineering systems and services (the `Systems Integration Contract'). Id. ¶ 83. Immediately upon entering into the Systems Integration Contract on March 31, 1996 and before doing any of the work on the Contract, Medaphis recognized $12.5 million of Joint Venture net earnings, thereby significantly improving reported revenues and net earnings for the first quarter of 1996. Id. Including this $12.5 million from the Systems Integration Contract allowed Medaphis to report a $13.2 million profit for the first quarter of 1996. Id.
Under GAAP principles. revenues from the Systems Integration Contract should not have been recognized until earned. "[R]evenues are considered to have been earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues." Id. ¶ 90. Defendants knew that recognizing the $12.5 million in revenues on March 31, 1996 was improper and deceptive because the Systems Integration Contract was subject to numerous contingencies and obligations and thus had produced no income on March 31, 1996. Id. ¶¶ 90-91, 131(h). Defendants knew that the collection of the sales price was not reasonably assured because Imonics, Inc. ("Imonics"), the Medaphis subsidiary responsible for meeting Medaphis's obligations under the Contract, was experiencing severe performance problems and was unable to perform its obligations under the Systems Integration Contract. Id.
Very soon after fraudulently including this $12.5 million in revenues, Medaphis began reporting significant problems with Imonics and its Systems Integration Contract. Id. ¶ 108. Medaphis later reported that it would incur significant financial charges in restructuring the Systems Integration Contract because of operational problems at Imonics. Id. ¶ 109. Plaintiffs allege that Defendants knew of Imonics's problems all along and knew that these problems would prevent Imonics from meeting its obligations under the Systems Integration Contract. Id. ¶ 69.
On July 23, 1996, Defendants issued a press release announcing Medaphis's financial results for the second quarter of 1996, ending June 30, 1996. Id. ¶ 104. Defendants reported that revenue for the second quarter was $175.2 million, up 24% from the second quarter of 1995. Id. Excluding merger and other one time costs, net income for the second quarter was up 159%, with earnings per share up 150%. Id. For the six months ending June 30, 1996, Medaphis reported a 255% increase in revenues, and a 500% increase in net income. Id.
These financial disclosures were prepared in violation of GAAP principles and were thus false and misleading. Id. ¶ 107. Medaphis's...
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