The opinion of the court was delivered by: BY THE COURT; HARVEY BARTLE, III
Plaintiffs bring this consolidated class action against American Travelers Corporation (ATC) and several of ATC's senior executives. Plaintiffs allege violations of the Securities Exchange Act of 1934 §§ 10(b) and 20(a), as amended by 15 U.S.C. §§ 78j(b) and 78t(a), and of Rule 10b-5 promulgated thereunder by the Securities and Exchange Commission. Plaintiffs also allege common law negligent misrepresentation under Pennsylvania Law. Defendants have moved to dismiss all counts pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure for failure to state a claim upon which relief can be granted, and for failure to plead fraud with particularity pursuant to Rule 9(b) of the Federal Rules of Civil Procedure.
Defendant ATC specializes in the underwriting and sale of supplemental accident and health insurance policies to senior citizens. ATC focuses its business on the segment of the senior citizen population that pays for long-term health care from their own personal resources. The company offers, among other products, long-term nursing home and home health care policies, designed to help policyholders defray the cost of nursing home confinement and home health care treatment. In addition, it offers Medicare Supplement coverage which provides payments to cover "deductibles" and other gaps in Medicare coverage. Prior to 1986, ATC conducted virtually all of its business in Pennsylvania. Since that time, ATC has sought to establish a national presence and is now licensed to conduct business throughout most of the United States. As a result of its rapid expansion, ATC achieved an unbroken string of record revenues and earnings from 1988 through 1990.
Plaintiffs allege that by early 1991, defendants knew that a shift in the company's product mix was occurring, with an increasing percentage of ATC's total annualized premiums generated by ATC's medicare supplement business. The medicare supplement business has a lower profit margin than the Company's long-term care business. The shift would therefore weaken the company's overall profitability. During the first and second quarters of 1991, ATC continued to report significant increases in revenues and net income. However, at the same time, the benefits paid out to policyholders increased dramatically and the company's overall loss ratio increased. During the third quarter of 1991, while ATC again reported an increase in revenues and net income, it described the increase as "lower then anticipated." The company disclosed that the sluggish third quarter was due mainly to costs associated with the medicare supplement business.
On March 3, 1992, ATC announced that its previously reported earnings for the second and third quarters of 1991 were incorrect, and that the company was restating those earnings. The company said it was correcting its second quarter net income by lowering it almost 25% to $ 2.6 million or $ .25 per share, compared to previously reported net income of $ 3.4 million or $ 0.30 per share. The company lowered its third quarter net income 20% to $ 2.9 million or $ 0.28 per share compared with previously reported net income of $ 3.6 million or $ 0.35 per share. Defendants stated that they undertook the restatement to correct errors in recording certain expenses and acquisitions completed during 1991. At the same time, ATC announced its financial results for the fourth quarter of 1991 and for the entire fiscal year. The company reported that although revenue increased by 53.6%, net income declined to $ 11.3 million or $ 1.09 per share for fiscal 1991 from $ 11.5 million or $ 1.32 per share for fiscal 1990. As a result of these announcements, trading in ATC's common stock, was temporarily halted on the NASDAQ/NMS. The company's stock, which had been trading as high as $ 20 per share during the class period, lost nearly 20% of its then total value and closed that day at $ 11.25 per share.
As stated above, defendants seek to dismiss plaintiffs' complaint under Rule 12(b)(6). When considering such a motion, the court must accept as true all allegations in the complaint, and all reasonable inferences which can be deducted therefrom. Rocks v. City of Philadelphia, 868 F.2d 644, 645 (3d Cir. 1989).
Plaintiffs allege accounting fraud in paragraphs 70(a)-(c) and (n) of the complaint. Defendants argue that the inaccurate disclosures concerning ATC's earnings set forth in these paragraphs merely describe errors in calculation, and are therefore non-actionable mismanagement. This contention is without merit. Rule 10b-5,
promulgated by the Securities and Exchange Commission under § 10(b) of the Exchange Act of 1934, makes it unlawful to misrepresent or omit material information in connection with the purchase or sale of securities. Shapiro v. UJB financial Corp. 964 F.2d 272 (3d Cir. 1992), cert. denied, 1992 WL 203119 (1992). In order to state a claim under § 10(b), and Rule 10b-5, plaintiff must plead a false representation of a material fact, the defendant's knowledge of its falsity, the defendant's intention that the plaintiff rely on it, the plaintiff's reasonable reliance on the representation, and the plaintiff's resulting loss. Id. Claims of mismanagement or breach of fiduciary duty unaccompanied by any "deception, misrepresentation or nondisclosure," do not constitute federal securities fraud. Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 97 S. Ct. 1292, 1302, 51 L. Ed. 2d 480 (1977).
In the instant case, however, plaintiffs allege more than mismanagement. They allege that defendants disseminated false financial information by deliberately or recklessly misstating ACT's earnings for the second and third quarters of 1991. False statements of material fact made knowingly or recklessly are actionable under § 10(b). Thus, plaintiffs' allegations of accounting fraud state a claim upon which relief can be granted.
Plaintiffs' allegations, contained in paragraphs 70(o) and (p) of the complaint, also withstand the motion to dismiss under Rule 12(b)(6). In these paragraphs plaintiffs allege that defendants falsely attributed the increases in benefits to policyholders and in ATC's overall loss ratio to the normal process of expansion. Plaintiffs contend that defendants failed to disclose that an "unhealthy" increase in medicare supplement claims caused a substantial portion of the increases. Here, plaintiffs have alleged a material and deliberate misrepresentation of fact by defendants, which is sufficient to state a claim under § 10(b).
One of our most significant accomplishments is the installation of a state-of the art computer system which encompasses all operating areas within the Company. As this new system gets fully implemented, it will greatly enhance our capacity and streamline our workflow . . .
(complaint at P31). Plaintiffs do not dispute that ATC purchased a "state of the art" computer system. They claim that contrary to defendants' promises, the system was in fact inadequate to serve the company's needs, and actually contributed to the company's rising costs. The challenged statement, however, indicates that the computer system would provide significant benefits only "when fully implemented." This suggests that ATC expected a transitional period during which problems would be worked out. Plaintiffs do not allege that the system was fully implemented at the time of the alleged problems. However, even if the computer system failed to live up to expectations after being "fully implemented," that would indicate mismanagement at the most. See Santa Fe 97 S. Ct. at 1296. The complaint does not allege that defendants knew or ...