Mass. Ret. Sys. v. CVS Caremark Corp.

• Decision Date: 24 May 2013
• Docket Number: No. 12–1900.,12–1900.
• Parties: MASSACHUSETTS RETIREMENT SYSTEMS, Lead Plaintiff, City of Brockton Retirement System; Plymouth County Retirement System; Norfolk County Retirement System, Plaintiffs, Appellants, Richard Medoff, individually and on behalf of all others similarly situated, Plaintiff, v. CVS CAREMARK CORPORATION; Thomas M. Ryan; David Rickard; Howard McLure, Defendants, Appellees.
• Court: U.S. Court of Appeals — First Circuit

716 F.3d 229

MASSACHUSETTS RETIREMENT SYSTEMS, Lead Plaintiff, City of Brockton Retirement System; Plymouth County Retirement System; Norfolk County Retirement System, Plaintiffs, Appellants,

Richard Medoff, individually and on behalf of all others similarly situated, Plaintiff,

v.CVS CAREMARK CORPORATION; Thomas M. Ryan; David Rickard; Howard McLure, Defendants, Appellees.

No. 12–1900.

United States Court of Appeals,First Circuit.

May 24, 2013.

Douglas Wilens, with whom Robbins Geller Rudman & Dowd LLP, Joseph A. Fonti, Serena Hallowell, and Labaton Sucharow LLP were on brief, for appellants.

Lawrence Portnoy, with whom Edmund Polubinski III, Jessica K. Foschi, Jason M. Spitalnick, Davis Polk & Wardwell LLP, William R. Grimm, and Hinkley, Allen & Snyder LLP were on brief, for appellees.

Before HOWARD, Circuit Judge, SOUTER,^* Associate Justice and TORRESEN,^** District Judge.

HOWARD, Circuit Judge.

This is an appeal from the dismissal of a putative class action for securities fraud against CVS Caremark Corporation and certain of its current and former employees. For the reasons below, we vacate the dismissal and remand the case for further proceedings.

I. Background

Because this appeal involves a dismissal for failure to state a claim, Fed.R.Civ.P. 12(b)(6), we recount the relevant facts based on the well-pleaded allegations in the complaint. SEC v. Tambone, 597 F.3d 436, 438 (1st Cir.2010) (en banc). At times, we borrow from the district court's thorough opinion.

A. CVS Merges with Caremark

In November 2006, CVS Corp. (“CVS”) and Caremark Rx Inc. (“Caremark”) announced that they would merge. At the time, CVS was the nation's largest retail pharmacy chain, and Caremark was the nation's second-largest prescription benefits manager (“PBM”). A PBM administers prescription drug benefits on behalf of employers, government agencies, labor unions, and other entities, known as “sponsors,” that provide those benefits as part of their health insurance plans. The sponsors pay fees to the PBM under a contract for its services, which include managing prescription drug claims submitted by those enrolled in the plan. PBMs also negotiate the prices that the sponsors pay to drug manufacturers for their products, which are then sold either through retail pharmacies (like CVS) that have their own contracts with the PBMs, or through the PBMs' own mail-order pharmacies. By merging, CVS and Caremark intended to provide services that only a combined retail pharmacy and PBM could offer, and to leverage their purchasing power to drive down their costs.

CVS President and CEO Thomas M. Ryan recognized that the combined company's success would depend on its ability to deliver quality service. On a conference call with analysts in November 2006, Ryan said that the combined company would “help employers and plan providers deliver the right drug at the right place at the right time.” At a March 2007 conference, Ryan stated,

No one is going to have a lower cost structure than this combined company. No one is going to be able to out-cost us in the market when we go. So, then it's all about, okay, what about service, what about product? And we think we can out-service and out-sell our competition here.

Ryan reiterated the importance of service on a May 2007 earnings call with analysts:

I guess the two things that [plan sponsors are] most concerned about, one is that there's no degradation of service. That's the first thing. And they want to get calmed down that, as I said earlier, that we're still going to focus on execution and service and we're confident that we are.

To provide effective service, CVS would have to integrate the computer systems of its own proprietary PBM, PharmaCare, with Caremark's. A failed integration could cause mistakes in the pricing and delivery of drugs. One analyst expressed “serious concerns about the ‘merger of equals' structure of the transaction and the heightened integration risk, given that both companies themselves have been active industry consolidators in the recent past.” In 2004, Caremark had become the then-largest PBM by merging with AdvancePCS, which itself was the product of a merger. According to a confidential witness, Caremark had a “myriad of systems, they basically let them be autonomous, and had tons of different systems so they didn't all talk to one another.” Nevertheless, a few days before CVS and Caremark shareholders approved the merger, Ryan expressed confidence about the prospects for integration:

Integration planning is on the way.... Caremark has done a lot of these. PharmaCare is relatively small. I don't mean to diminish any integration because there's always risk, but it's relatively straight-forward....

CVS and Caremark completed their merger in March 2007, creating CVS Caremark Corporation (“CVS Caremark”). Ryan became the President and CEO of CVS Caremark; David Rickard, who had been the Executive Vice President and CFO of CVS, retained these titles at the merged company; and Howard McLure, who had been the Senior Executive Vice President and COO of Caremark, became the President of Caremark Pharmacy Services, a division of CVS Caremark.

B. Misrepresentations About Service and Integration

After the merger, Ryan claimed that CVS Caremark had integrated its computer systems, was providing excellent service, and was maintaining its client base. In November 2007, Ryan said that he was “pleased that we've completed the integration of both the organization and back end systems quickly and successfully.” ¹ On a conference call with analysts on October 30, 2008, the first day of the class period, Ryan stated, “Even in these difficult and uncertain times ... our PBM continues to retain existing clients and attract new ones. We will continue to gain share because ... [w]e have excellent service.” Ryan acknowledged that CVS Caremark had lost some major clients, but he said that new business would roughly offset the losses: “For 2009 revenue impact perspective, the wins and losses are in fair balance.” In the following days, analysts reacted positively to the prospects of CVS Caremark's PBM business.

In January 2009, Ryan stated on an earnings guidance call that CVS had secured many of its “2009 wins” because it “repriced a significant amount of business” in order to take certain “key accounts ... off the table and reprice early for all the reasons that you can imagine.” This repricing included discounts not only on contracts that were up for renewal, but also on contracts that were set to expire in 2010 and beyond. According to Ryan, “over half of our PBM business received improved pricing and close to 70% of our national accounts were repriced.” Reacting to this news, an analyst asked Ryan, “Is there a concern about the service for the systems and how can you get people past that also for 2010?” Ryan denied that concerns about service caused the repricing, stating that there were “[n]o trade-offs because of our service” or “hidden agenda here about giving a lower price because of lack of service.” Another analyst asked Ryan whether CVS Caremark's systems “are able to talk to each other.” Ryan responded, “All the systems are able to talk to each other.... We have got no issue with our systems.” Again, analysts reacted positively to the prospects of CVS Caremark's PBM business.

CVS Caremark continued to proclaim good news as 2009 wore on. During another earnings call in February 2009, Ryan stated that in 2008, CVS Caremark's PBM business “had an excellent client retention and achieved all time industry sales and new business growth.... So for anyone wondering if our offerings are resonating they certainly are.” CVS Caremark's Form 10–K for its 2008 fiscal year, filed later that month, struck a similarly upbeat tone: “We believe the breadth of capabilities resulting from the Caremark [m]erger are resonating with our clients and contributed to our success at renewing existing clients and obtaining a significant number of new clients in the 2008 selling season.” Rickard, the Executive Vice President and CFO of CVS Caremark, used similar language during a meeting with institutional investors on March 10, 2009, telling them that “our model is resonating in the PBM marketplace.” Rickard further stated that “we have done the things strategically that needed to be done to make this merger successful.” In two presentations to analysts in May, Ryan stated that “[a]s far as the 2010 pipeline ... we're essentially on plan, in good shape,” and reiterated that “[w]e are exactly where we need to be from a re-upping contract standpoint. So from the PBM side of our business, we're in good shape.” On the company's earning conference call in August, Ryan forecasted earnings for 2010: “I would be very disappointed if we didn't have an [earnings per share] growth of at least 13 to 15% next year.” Glowing reports from analysts followed Ryan's statements.²

C. The Truth About the Merger

The complaint alleges that all of these statements concealed that the merger was, in fact, a disaster. According to confidential witnesses, problems with the integration of computer systems following the merger caused mistakes that contributed to the loss of major clients. Three of these clients were worth $3 billion in annual revenue to CVS Caremark: Coventry, Horizon Blue Cross Blue Shield of New Jersey (“New Jersey”), and Chrysler.

CVS Caremark lost its Medicare Part D, or “Med–D” business with Coventry in 2008,³ and the remainder, known as the “commercial business,” followed in 2009. In 2008, Rickard claimed that the loss of the Med–D business was “due in large part to price.” But according to a former CVS Caremark employee, problems with the integration of computer systems often resulted in CVS Caremark representatives being unable to access participants' information. Participants also complained that they were told that they would receive a prescription drug at a certain price, but they would be given a more...