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J/H REAL ESTATE INC. v. ABRAMSON

October 25, 1995

J/H REAL ESTATE INC., individually and on behalf of all others similarly situated
v.
LEONARD ABRAMSON, et al.



The opinion of the court was delivered by: BARTLE

 Bartle, J.

 October 25, 1995

 Plaintiff brings this purported class action against U.S. Healthcare, Inc. ("USHC") and two of USHC's top executives. *fn1" In Count I of the complaint, plaintiff alleges violations of §§ 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, 15 U.S.C. §§ 78j(b) and 78t(a), and of Rule 10b-5 promulgated thereunder by the Securities and Exchange Commission ("SEC"). Plaintiff claims, in Count II of the complaint, common law negligent misrepresentation under Pennsylvania law. Before the court is defendants' motion to dismiss the complaint 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. Defendants also move to dismiss for failure to plead fraud with particularity pursuant to Rule 9(b) of the Federal Rules of Civil Procedure. *fn2"

 Plaintiff seeks to represent a class of stockholders (the "Class") who purchased the Class A common stock of USHC between October 5, 1994 and April 19, 1995, inclusive (the "Class Period"). Compl. at P 1. Plaintiff alleges USHC specializes in managed health care insurance plans, including health maintenance organizations. Id. at P 10. According to the complaint, USHC competes against other managed care companies by maintaining its health care expenses at low levels in proportion to the premium income generated by USHC through its health care underwriting activity. Id. at PP 22, 37, 50. By focusing on costs, USHC achieves a relatively low medical loss ratio ("MLR"). MLR is the ratio of medical expenses paid by USHC to its underwriting income. Id. at PP 22, 50. A low MLR means high profit margins and strong profitability. Id. at PP 22, 50.

 During the Class Period, defendants allegedly engaged in a scheme to defraud plaintiff and the Class by consistently portraying USHC's operations and future prospects in a positive light despite the fact that defendants were in possession of materially adverse information. Id. at PP 2, 76-89. As a result of that supposedly fraudulent scheme, USHC's stock price was artificially inflated throughout the Class Period. Id. at P 5. Consequently, plaintiff claims it and the putative class members were damaged by defendants' misconduct because each purchased USHC stock at prices which would not have been paid had there been full and adequate disclosure of the true facts concerning USHC's business and future prospects. Id. According to plaintiff's complaint, USHC had decided by October 5, 1994 to reverse its strategy of steadily lowering medical costs as a percentage of premium income. Id. at PP 50, 56. By that time defendants had allegedly begun to implement a strategy to lower dramatically its health care premiums while at the same time dramatically increasing its health care expenses. Id. at PP 58-59, 64-65. These changes, which were meant to meet competition, resulted in USHC increasing its MLR from 300 to 400 basis points by April 19, 1995. Id. at P48. Plaintiff contends that between April 19 and 20, 1995 USHC's shift in its revenue and cost structure resulted in a 25% decline in the market value of USHC stock. Id. at PP 47, 49.

 As noted, defendants seek to dismiss plaintiff's complaint under Rule 12(b)(6) for failure to state a claim upon which relief can be granted. 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). Generally, the court may "... consider only the allegations contained in the complaint, exhibits attached to the complaint and matters of public record." *fn3" Pension Benefit Guar. Corp. v. White Consol. Indus., 998 F.2d 1192, 1196 (3d Cir. 1993). Nonetheless, the Court of Appeals in Pension Benefit explained that in deciding a Rule 12(b)(6) motion, "a court may consider an undisputedly authentic document that a defendant attaches as an exhibit to a motion to dismiss if the plaintiff's claims are based on the document." Id. In that case the plaintiff had sued to recover unfunded pension benefits and based its claim on a written contract between the parties. Id. 1195-96. Even though the contract itself was not attached to the complaint, Pension Benefit declared that the court could take the document into account in determining the defendant's motion to dismiss. 998 F.2d at 1196-97. However, if a party relies on materials outside the narrow limits set forth in Pension Benefit, Rule 12(b)(6) requires the court to treat the motion as one for summary judgment under Rule 56. Under those circumstances the party opposing the motion must be given a reasonable opportunity to conduct any necessary discovery and present all pertinent material. See Fed. R. Civ. P. 56(f); Vosgerichian v. Commodore Int'l, 862 F. Supp. 1371, 1375 (E.D. Pa. 1994).

 In the instant case, defendants rely on 39 documents in support of their motion to dismiss. Thirty-two of these documents were not referred to or relied upon by the plaintiff in the complaint and are not public records. They are press releases, securities analyst reports, teleconference transcripts, and magazine and newspaper articles. Thus, Pension Benefit prohibits us from making use of these documents in connection with a Rule 12(b)(6) motion. Pension Benefit, 998 F.2d at 1196-97.

 The remaining seven documents, on which defendants rely, are: (1) an excerpt from USHC SEC Form 10-Q for third quarter 1994; (2) an excerpt from USHC SEC Form 10-Q for second quarter 1994; (3) an excerpt from USHC 1994 Annual Report; (4) an excerpt from USHC SEC 1994 Form 10-K; (5) Donaldson Lufkin & Jenrette Securities analyst report of Dec. 8, 1994; (6) SEC Form 4 Statement of Changes in Beneficial Ownership for Leonard Abramson of Nov. 8, 1994; and (7) SEC Form 4 Statement of Changes in Beneficial Ownership for Costas Nicolaides of Dec. 1, 1994. See Defendants' Appendix to their Motion to Dismiss Exhibits 1-4, 7, 12-13. These are either public records filed by the defendants with the SEC or material on which plaintiff relies in its complaint. Accordingly, the court may properly take into account these seven references in passing upon defendants' motion to dismiss. Pension Benefit, 998 F.2d at 1196-97.

 Defendants first contend that their motion to dismiss Count I of the complaint should be granted under the "bespeaks caution" doctrine. This doctrine provides that:

 
... when an offering document's forecasts, opinions or projections are accompanied by meaningful cautionary statements, the forward-looking statements will not form the basis for a securities fraud claim if those statements did not affect the "total mix" of information the document provided investors. In other words, cautionary language, if sufficient, renders the alleged omissions or misrepresentations immaterial as a matter of law.

 In re Trump Casino Sec. Litig., 7 F.3d 357, 371 (3d Cir. 1993). In order to decide whether cautionary statements render the misrepresentations and omissions immaterial, a defendant must establish that the cautionary statements "discredit the other one so obviously that the risk of real deception drops to nil." Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083, 115 L. Ed. 2d 929, 111 S. Ct. 2749 (1991). Furthermore, "disclaimers must relate directly to that on which investors claim to have relied." Kline v. First W. Gov't Sec., Inc., 24 F.3d 480, 489 (3d Cir. 1994). On the other hand, a "vague or blanket (boilerplate) disclaimer which merely warns the reader that the investment has risks will ordinarily be inadequate to prevent misinformation. To suffice, the cautionary statements must be substantive and tailored to the specific future projections, estimates or opinions in the prospectus which plaintiffs challenge." Trump Casino, 7 F.3d at 371-72.

 In Trump Casino, plaintiffs alleged that the prospectus accompanying the issuance of the bonds related to building the Taj Mahal casino in Atlantic City was materially misleading because it failed to disclose that:

 
... 1) the Taj Mahal required an average "casino win" of approximately $ 1.3 million per day on a continuing basis in order to service its debtload; 2) Donald Trump had personally guaranteed hundreds of millions of dollars in bank loans for other properties; ...

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