Securities Fraud Class Action Properly Dismissed for Failure to Adequately Plead Falsity and Scienter because Allegations in Class Action Complaint did not Meet Heightened Pleading Requirements Under Private Securities Litigation Reform Act of 1995 (PSLRA) Eighth Circuit Holds
Plaintiffs filed a class action against Centene Corporation and three of its officers alleging violations of federal securities law; the class action complaint alleged violations of sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and of Rule 10b-5. Elam v. Neidorff, 544 F.3d 921, 924-25 (8th Cir. 2008). The class action centered on the company’s estimates of costs that had been “incurred but not reported” (IBNR). According to the class action, Centene – a “healthcare enterprise that primarily provides programs and related services to individuals receiving benefits under Medicaid,” acted as “an intermediary between the government and Medicaid recipients in the states” and “receive[d] a monthly amount for each Medicaid recipient in its plan and, in turn, [paid] for the recipient’s healthcare services.” Id., at 925. In filing its quarterly reports, the company “include[d] not only the costs incurred and billed during the quarter but also an estimate of medical costs that have been incurred but not reported (IBNR).” Id. Centene’s calculation of IBNR was necessarily an educated guess: it represented “an estimate of claims liability because some medical events occur before the end of a given reporting period (and Centene is therefore liable to pay them) but have not yet been formally billed to the company,” and Centene calculated the estimate “on a monthly basis employing various factors, including in-patient hospital utilization dates and prior claims experience.” Id. Moreover, “Independent actuaries review Centene’s quarterly estimates.” Id. In April 2006, Centene filed its Form 10-Q with the SEC and issued a press release that “were positive and in line with analyst estimates,” and providing positive guidance for the second quarter as well as the balance of the year. Id., at 925-26. In July 2006, the company disclosed that second quarter earnings would be “substantially lower than expected,” and this securities fraud class action complaint soon followed. Id., at 926. Defense attorneys moved to dismiss the class action complaint on the grounds that it failed to satisfy the heightened pleading requirements established by the Private Securities Litigation Reform Act of 1995 (PSLRA); the district court granted the motion and dismissed the class action “finding that plaintiffs failed to allege facts demonstrating that defendants had misrepresented a material fact or acted with scienter.” Id., at 926. The Eighth Circuit affirmed.
After summarizing the “heightened pleading requirements” imposed by the PSLRA on securities fraud cases (class action and non-class action), Elam, at 926-27, the Eighth Circuit turned its attention to plaintiffs’ claim that the class action complaint “sufficiently alleges both falsity and scienter, satisfying the elevated pleading standard for their securities fraud class action,” id., at 927. The Circuit Court held that the mere fact defendants “monitored” its medical costs was insufficient under the PSLRA to establish that defendants knew of information that contradicted any of the financial statements they made, id. The Eighth Circuit refused plaintiffs’ invitation to infer that defendants’ statements were false “based solely on defendants’ representations as to their ability to estimate medical costs.” Id. On the contrary, the PSLRA’s heightened pleadings standards requires that falsity be pleaded with particularity, and this requirement “cannot be satisfied with allegations that defendants made statements ‘and then showing in hindsight that the statement is false.’” Id. (quoting In re Navarre Corp. Sec. Litig., 299 F.3d 735, 743 (8th Cir. 2002)). Plaintiffs’ failure to “point to any contemporaneous reports, witness statements, or any information that had actually been provided to defendants as of April or June that indicated that Centene would need to increase estimated medical costs” was fatal to the class action. Id. (citation omitted). The Circuit Court therefore affirmed the district court’s conclusion that falsity had not been adequately pleaded. Id., at 927-28.
The Eighth Circuit then summarized the requirements for establishing scienter in securities fraud cases, see Elam, at 928, and rejected each ground advanced by plaintiffs on appeal. We note in particular the Circuit Court’s conclusion that the questioned stock sales were part of a Rule 10b5-1 trading plans, in place since December 2005, and amounted to no more than 5% of the two individuals’ stock holdings, so the sales did not create an inference of scienter. Id., at 928-29. The Court found plaintiffs’ other theories to be conclusory and wholly speculative, see id., at 929-30. The Eighth Circuit therefore affirmed the dismissal of the class action complaint, id.
NOTE: The Form 10-Q specifically warned, “Failure to Accurately Predict Our Medical Expenses Could Negatively Affect Our Reported Results. Our medical expenses include estimates of IBNR medical expenses. We estimate our IBNR medical expenses monthly based on a number of factors. We cannot be sure that our IBNR estimates are adequate or that adjustments to those estimates will not harm our results of operations. From time to time in the past, our actual results have varied from our estimates, particularly in times of significant changes in our members. Our failure to estimate IBNR accurately may also affect our ability to take timely corrective actions, further harming our results.” See Elam, at 925.