Kushner v. Beverly Enterprises, Inc.

Decision Date23 January 2003
Docket NumberNo. 01-3677.,01-3677.
Citation317 F.3d 820
PartiesJack KUSHNER, Travis Q. Richardson, Eric Green, Samuel Halkias, Norman M. Lyons, James M. Swedenberg, Christopher R. Stang, Florence D. Wiener, Jules A. Wiener, Marc Shechtman, Appellants, v. BEVERLY ENTERPRISES, INC.; David R. Banks; Boyd W. Hendrickson; Scott M. Tabakin; Pamela H. Daniels, Appellees.
CourtU.S. Court of Appeals — Eighth Circuit

Mark I. Gross, argued, New York, NY, for appellants.

Paul H. Dawes, argued, Menlo Park, CA (M. Samuel Jones, III, and Curtis P. Lu, on the brief), for appellees.

Before HANSEN, Chief Judge, McMILLIAN and JOHN R. GIBSON,1 Circuit Judges.

HANSEN, Circuit Judge.

Investors Jack Kushner, Travis Q. Richardson, Eric Green, Samuel Halkias, Norman M. Lyons, James M. Swedenberg, Christopher R. Stang, Florence D. Wiener, Jules A. Wiener, and Marc Shechtman (collectively "the investors") brought this securities fraud suit against Beverly Enterprises, Inc. (Beverly) and its directors David R. Banks, Boyd W. Hendrickson, Scott M. Tabakin, and Pamela H. Daniels. The district court2 dismissed the investors' second amended complaint for failure to state a claim upon which relief could be granted. The investors now appeal, and we affirm the dismissal of their complaint.


We review de novo the district court's decision to dismiss the complaint for failure to state a claim under Rule 12(b)(6) of the Federal Rules of Civil Procedure. Florida State Bd. of Admin. v. Green Tree, 270 F.3d 645, 661 (8th Cir.2001). The Private Securities Litigation Reform Act of 1995, Pub.L. No. 104-67, 109 Stat. 737 (the Reform Act), however, dictates a modified analysis due to its special heightened pleading rules. As always, we must view the factual allegations in the light most favorable to the plaintiff, Parnes v. Gateway 2000, Inc., 122 F.3d 539, 546 (8th Cir.1997), but at the same time, in the context of securities fraud, we must "disregard `catch-all' or `blanket' assertions that do not live up to the particularity requirements of the [Reform Act]," Green Tree, 270 F.3d at 660.

Beverly owns and operates numerous health care facilities throughout the United States and participates in the Medicare reimbursement program. In 1995, a private person instituted a qui tam action against Beverly in federal court in Arizona. On July 23, 1998, the company publicly disclosed that it was the subject of an investigation by the federal government relating to its compliance with the Medicare program. After the public announcement of the government investigation, Beverly's stock price plummeted, resulting in substantial losses for investors who had purchased stock at higher prices. In November 1998, Beverly announced that the civil investigation had been expanded to a criminal investigation by a grand jury in San Francisco and that two former employees were identified as the targets of the investigation.

The investors brought this securities fraud suit in 1998 both individually and purporting to represent a class of all persons who purchased common stock and convertible debentures of Beverly from October 19, 1995, through July 23, 1998. They claimed that Beverly and its directors had engaged in fraudulent representations that affected the purchase or sale of securities in violation of the Securities Exchange Act. Count I of the second amended complaint alleges that Beverly and the named individual officers violated Section 10(b) of the Securities Exchange Act, 15 U.S.C. § 78j(b) and 78t (1994), and Rule 10b-5, 17 C.F.R. § 240.10b-5, by knowingly making false and misleading statements that caused the investors to purchase stock at artificially inflated prices. The complaint asserts that at the direction of senior officers, Beverly falsified daily nurses' sign-in sheets by requiring the nurses to record only the total number of hours worked. Subsequently, the director of nursing would allocate the time between Medicare patients and non-Medicare patients pursuant to a set formula or a targeted number of hours, heedless of the actual time that nurses spent caring for Medicare patients. Thus, the resulting Medicare reimbursement for nursing time spent on Medicare patients was artificially inflated. The complaint alleges that as a result of this fraudulent scheme, the company's financial statements overrepresented Beverly's true earnings to the detriment of investors, and its statement of compliance with Medicare laws was false and misleading.

Count II of the second amended complaint asserts that the individual defendants are liable as "controlling persons" within the meaning of Section 20(a) of the Securities Exchange Act, 15 U.S.C. § 78t(a), because they allegedly controlled the policies of overcharging Medicare as well as the content of the public statements that misled investors. In August 1999, Beverly announced that it had reached a tentative settlement with the government resolving the civil investigation by agreeing to "reimburse" the government $170 million based upon fraudulent nursing claims from the years 1990 to 1998. (J.A. at A-34.) The second amended complaint, filed in September 1999, referenced this settlement of the civil suit.

Beverly and the individual defendants moved to dismiss for failure to state a claim, maintaining that the second amended complaint lacked sufficient particularity and the required strong inference of scienter necessary to state a claim of securities fraud. Specifically, the defendants asserted that the complaint lacked any allegation that they knew of Medicare violations or that the company's financial statements were overrepresented at the time they stated that the company was in compliance with Medicare laws and filed the financial statements.

The investors attached a criminal plea agreement to their supplemental opposition to the motion to dismiss in an attempt to demonstrate knowledge or recklessness. In February 2000, Beverly Enterprises-California, a wholly owned subsidiary of Beverly, entered into a plea agreement with the government, admitting that it had submitted ten false claims to Medicare. The California subsidiary admitted to calculating nursing costs based on prescribed formulas which ensured revenue levels rather than being based on actual Medicare nursing costs and agreed to pay a criminal fine of $5 million. Defendant Banks signed the plea agreement on behalf of the California subsidiary. In exchange for the plea, the government agreed not to file any more charges against the California subsidiary or its parent corporation based on nursing costs from 1992 through 1998. The plea agreement admits no wrong on the part of the parent corporation and implicates no wrongdoing on the part of any individually named defendant. The defendants did not object to the district court considering this document.

The district court granted the motion to dismiss for failure to state a claim. The court also denied the investors' second motion to take judicial notice of certain documents. The investors appeal.

A. Securities Fraud and Controlling Person Claims

The district court concluded that the second amended complaint failed to state a claim of securities fraud because the complaint failed to allege scienter to the level required by existing law, that Beverly's opinion regarding the legality of its billing practices under Medicare regulations was "soft information" which it had no duty to disclose, and that the case involved fraud on the part of a handful of employees at a handful of facilities, as demonstrated in the criminal plea agreement, rather than a company-wide scheme to engage in federal securities fraud. Then, finding no stated claim of securities fraud, the district court concluded that the "controlling person" claim necessarily failed as well.

"Rule 10b-5, promulgated by the Securities and Exchange Commission under section 10(b) of the Act, prohibits fraudulent conduct in the sale and purchase of securities," and section 20 extends liability for this conduct to any "controlling person." In re Navarre Corp. Sec. Litig., 299 F.3d 735, 741 (8th Cir.2002) (citing 15 U.S.C. § § 78j, 78t(a); 17 C.F.R. § 240.10b-5). "Complaints brought under Rule 10b-5 and section 10(b) are governed by special pleading standards adopted by Congress in the [Reform Act]. These pleading standards are unique to securities and were adopted in an attempt to curb abuses of securities fraud litigation." Navarre Corp., 299 F.3d at 741.

Congress enacted two heightened pleading requirements in the Reform Act. First, the Reform Act requires the plaintiff's complaint to specify each misleading statement or omission and specify why the statement or omission was misleading. 15 U.S.C. § 78u-4(b)(1) (Supp. IV 1998). If the allegation "is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." Id. Similarly, Rule 9(b) of the Federal Rules of Civil Procedure has long required that "in all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." The text of the Reform Act was designed "to embody in the Act itself at least the standards of Rule 9(b)." Greebel v. FTP Software, Inc., 194 F.3d 185, 193 (1st Cir.1999).

Second, Congress stated in the Reform Act that a plaintiff's complaint must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2); Green Tree, 270 F.3d at 654. The Reform Act requires the court to dismiss the complaint if these requirements are not met. 15 U.S.C. § 78u-4(b)(3). "[U]nder the Reform Act, a securities fraud case cannot survive unless its allegations collectively add up to a strong inference of the required state of mind." Green Tree, 270 F.3d at 660....

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