The opinion of the court was delivered by: O'neill, J.
On October 27, 2007, plaintiff Southeastern Pennsylvania Transportation Authority, Inc. (SEPTA), both individually and on behalf of others similarly situated, filed a class action complaint against defendants Aetna, Inc., John W. Rowe, Ronald A. Williams, Alan M. Bennett and Craig R. Callen.
In an Order dated February 29, 2008, I consolidated the class actions filed in this Court and any other similar actions against defendants filed in or transferred into this District and named plaintiff Varma Mutual Pension Insurance Company as lead plaintiff. Plaintiffs, purchasers of Aetna securities during the period from October 27, 2005 through July 27, 2006, filed a consolidated class action complaint on June 2, 2008 alleging that all defendants violated Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78 and Rule 10b-5 promulgated thereunder (Count I), 17 C.F.R. § 240.10b-5, that individual defendants Rowe, Williams, Bennett and Callen violated Section 20(a) of the Securities Exchange Act (Count II) and that all defendants violated Section 18 of the Securities Exchange Act (Count III).
Before me now are defendants' motion to dismiss lead plaintiff's consolidated amended class action complaint pursuant to Federal Rules of Civil Procedure 12(b)(6) and 9(b) and the Private Securities Litigation Reform Act of 1995 (PSLRA), plaintiff's response and defendants' reply thereto.
Defendant Aetna*fn1 is a diversified health care benefit company offering traditional and consumer-based health insurance products and related services, including medical, pharmacy, dental, behavioral health, group life, long-term care and disability plans and medical management capabilities. Plaintiff alleges that Aetna's typical customers include employer groups, individuals, college students, part-time and hourly workers, health plans and government-sponsored plans.
Over the course of the class period, individual defendants Rowe, Williams, Bennett and Callen served in various leadership capacities at Aetna. Defendant Rowe served as Chairman of Aetna from April 1, 2001 until his retirement on October 1, 2006 and served as President from September 15, 2000 until May 27, 2002 and Chief Executive Officer from September 15, 2000 through February 14, 2006. Defendant Williams served as President of Aetna from May 27, 2002 through July 24, 2007 and has been Aetna's CEO since February 14, 2006 and Chairman since October 1, 2006. Defendant Bennett was Senior Vice President and Chief Financial Officer during the class period. Defendant Callen joined Aetna as Senior Vice President and Head of Strategic Planning and Business Development on April 28, 2004 and maintained that position during the class period.
Plaintiff Varma is a Helsinki, Finland-based pension company that manages mutual funds assets for its members. Plaintiff alleges that it purchased Aetna securities during the class period.
I. Alleged Fraudulent Scheme
Aetna, like other health care companies, uses medical cost ratios (MCR)*fn2 as a key measure of its profitability and future prospects. The lower the MCR, i.e., the lower medical costs are relative to premiums, the more profitable Aetna appears to analysts and investors. A higher MCR signals to the market that an insurer is experiencing higher medical costs that are not being offset by a corresponding increase in premiums, thereby making the business less profitable.
Plaintiff asserts that since at least April 2005, Aetna had been telling investors that it practices "disciplined pricing," i.e., achieves premium yields in line with medical cost trends or increases in premiums at the same percentage as medical costs are increasing. Plaintiff cites numerous examples of defendants' statements in which they describe this "disciplined pricing" practice throughout the class period which are described in detail below.
By December 30, 2005, plaintiff alleges that Aetna's share price had climbed to a split-adjusted closing price of $47.07 per share and stood at a closing price of $48.61 per share as the month of February 2006 opened.*fn3 On February 9, 2006, plaintiff alleges that Aetna announced its results for Q4 2005. At that time, Aetna stated that operating earnings, excluding prior-period favorable reserve development, were $1.26 per share, an increase of 38% compared to the prior-year quarter, and that "[t]he increase in operating earnings reflect[ed] a 14 percent increase in revenue from strong membership growth, as well as strong underwriting results and continued general and administrative expense efficiencies." Plaintiff asserts that, in its earnings release, Aetna reported a Commercial Risk MCR of 76.8% in Q4 2005, compared to 77.6% in Q4 2004.
During Aetna's February 9, 2006 conference call, plaintiff alleges that defendants Williams and Rowe both emphasized that Aetna continued to adhere to its pricing discipline. Plaintiff alleges that the market reacted favorably to this information; Aetna's shares, which had closed on February 8, 2006 at $47.98 per share, reached $52.48 per share by February 23, 2006.
Plaintiff asserts that, starting no later than September 2005, about one month prior to the October 27, 2005 Q3 earnings release, defendants concealed from investors that Aetna had begun charging too little for its health insurance products for the purpose of boosting Aetna's membership rosters. As reflected in a Reuters article dated April 27, 2006, FTN Midwest Securities conducted a survey that analyzed pricing by Aetna and plaintiff alleges that it demonstrated that Aetna aggressively under-priced the market to bring in new business. The Reuters article states:
HMOs have posted high profits even amid rapid medical cost inflation by jacking up their premiums. Now, pricing competition among the top players remains a worry, particularly at Aetna. FTN Midwest Securities published a survey last year which showed that despite steady increases in its premiums, Aetna most aggressively underpriced its peers to bring in new corporate business. "We believed Aetna is the most aggressive pricer in the marketplace, and it appears from this quarter, they are," FTN Midwest analyst Peter Costa, who has a "neutral" rating on the stock, said. Costa also noted financial results from Wellpoint and UnitedHealth Group Inc. [both Aetna competitors], bear that out, as they both had weaker-than-expected commercial membership. Membership in Aetna's health plans rose to 15.4 million, up 663,000 members.
Plaintiff asserts that FTN's survey documents that Aetna's under-pricing began in September.*fn4
Plaintiff asserts that, according to an article appearing in Barron's Online dated August 21, 2006, Aetna began under-pricing its plans in September 2005. The article states:
[Peter] Costa . . . [, an analyst who covers Aetna for FTN Midwest Securities,] says that, based on interviews last September with benefit consultants and insurance brokers, "we concluded that Aetna was being the most aggressive in pricing" the national accounts, each of which covers at least 3,000 people. After Aetna's stock blew up [in April 2006], "we found they were being less aggressive," he notes.
Plaintiff alleges that the FTN survey's conclusions about Aetna's under-pricing as reported by Reuters and Barron's is corroborated by accounts of former Aetna employees who believed under-pricing either did or may have occurred at Aetna in 2005 and/or 2006.
Plaintiff alleges that Confidential Witness 1 (CWl), an Aetna employee from January 1995 to July 2006, was a process leader for national accounts responsible for putting together new business proposals for national accounts consisting of 3,000 or more employees. CW1 was "as busy as ever" with proposals for national accounts 12 to 18 months prior to CWl's departure. CW1 believed that during the second half of 2005 and the first half of 2006, there was "a big push to get national account business, even if [Aetna] did not make any money." CWl suggests that Aetna was willing to lose money on an account in hopes of meeting membership goals. Plaintiff claims that CWl attended meetings and received emails from six or seven regional heads telling CWl to put together the proposals even if it meant that Aetna would lose money.
Plaintiff alleges that CWl stated that Aetna's goal was to get the customer, even if it meant that Aetna would lose money on one, three, or five-year contracts. CW1 stated that Aetna hoped to make up the losses after the customer renewed the contract and that entering into money-losing contracts was a "common practice" for Aetna because competition was tough. CW1 provided Applera Corporation, located in Norwalk, Connecticut, as an example of a dental-only customer with which Aetna had entered into a money-losing contract for three years. Actuaries informed CW1 what the expenses were for each account, so CW1 could tell when Aetna lost money on an account. CW1 stated that CW1 believed that Aetna lost money on 30% to 40% of its renewal and new customer contracts.
Similarly, plaintiff alleges that Confidential Witness 2 (CW2), an underwriting analyst, said that as early as CW2's first day of work at Aetna, CW2 noticed that colleagues were complaining about the company's "pricing" practices. CW2's underwriting practice was focused on small groups and CW2 said there was a boost in small group customers from the time CW2 started until at least 2006, but stressed that even though there were new accounts coming in the business was not nearly as lucrative as it might have been in years past. Plaintiff asserts that this was due, in part, to the fact that CW2 was increasingly pressed by supervisors to accept "high risk groups." Using rates provided by CW2's bosses that were calculated by actuaries, CW2 would integrate the data that CW2 had collected about the small company in question and determine a "quote" to present to the broker. If the broker balked at the price, CW2 was authorized to work with the broker to lower the quote.
Plaintiff alleges that CW2 stated that this process typically meant taking "drastic measures" and "overlooking a pre-existing condition" that Aetna typically did not accept without high rates. To get the sale, CW2 said that Aetna was "not going to scrutinize." For example, CW2 recalled that Aetna began accepting high blood pressure as a condition that would not merit a hike in the customer's premium whereas previously such a condition would require a higher rate. CW2 would run the calculations by CW2's supervisor and was almost always permitted to allow the pre-existing condition at a lower premium. The willingness of supervisors to go so low in a quote was frustrating to CW2 and CW2's colleagues who told supervisors to "stop being so lenient." Even though this may have helped CW2 make CW2's numbers in the short run by bringing in new small groups, CW2 felt the process was "misleading to employees and shareholders." CW2 stated that as long as CW2 was booking new business, CW2 knew that Aetna's numbers would look good. However, CW2 also stated that by allowing certain pre-existing conditions in at low premiums, Aetna's pricing policy decreased its profit margins. According to CW2, it made sense that the projected MCR went up in the beginning of 2006 because that was the time that claims were increasing as a result of Aetna's "leniency." During CW2's time at Aetna, CW2 asserts that no small group application was ever turned away. CW2 stated that "[Aetna] used no discretion to get the sale."
Plaintiff asserts that Confidential Witness 3 (CW3) further confirmed Aetna's under-pricing activity as an Aetna underwriter and salesperson. It was CW3's impression that Aetna was "very aggressive" and that when entering a marketplace, Aetna would "initially offer an attractive rate in order to hit membership targets." CW3 provided the group information to the underwriters, and they would provide CW3 with the group's rates. CW3 said that the "rates set were not sustainable" and that they were "particularly aggressive." According to plaintiff, CW3 also recalled hearing that small group business in other areas were priced "aggressively" and at unsustainable rates at various times. CW3 provided the following examples of places and time periods during which the pricing was particularly low: Georgia (2005-2006) and Ohio, particularly around Cleveland (2005 through early 2007).
Plaintiff alleges that defendants' fraudulent scheme was exposed when Aetna announced on April 27, 2006 that its MCR of 79.4% for the first quarter 2006 was much higher than anticipated. Aetna's April 27, 2006 announcement revealed that first quarter 2006 MCR was 1.5% (150 basis points) higher than the year-earlier first quarter and 1.3% (130 basis points) higher than in the fourth quarter of 2005.
Following the April 27, 2006 announcement regarding the increase in MCR, plaintiff asserts that Aetna's stock fell substantially. From April 26, 2006 to April 27, 2006, Aetna's stock fell from $46.43 per share to $37.00 per share, a decline of $9.43 per share, or over 20 percent, representing a loss in market capitalization of $5.4 billion.
After being told on February 9, 2006 that Aetna's Q1 2006 MCR would be the lowest for the year, plaintiff alleges that the dramatic increase in MCR caused analysts with SG Cowen & Co. and the Wall Street Journal to become concerned that Aetna was in fact under-pricing compared with competitors WellPoint and UnitedHealth and suggesting that it was a departure from its previous pricing discipline.
Plaintiff alleges that defendants continued to mislead the public by failing to advise analysts and investors of Aetna's practice of under-pricing and its resultant effect on the first quarter MCR in a follow-up conference call on May l, 2006. Plaintiff asserts that defendants knowingly mis-attributed the cause of the high MCR to other factors, while steadfastly maintaining that Aetna's higher-than-expected membership growth was "solid and balanced growth that is representative of our dedication to disciplined pricing." Moreover, plaintiff alleges that defendants continued to make false and misleading statements while claiming that the MCR would be up "slightly" during the second quarter when it alleges that defendants knew there would be a substantial increase in the second quarter as well due to Aetna's under-pricing. Finally, during the same call, Aetna advised that it was lowering its projected full-year MCR guidance from 80% to 79% which plaintiff claims "comforted" analysts, but that defendants knew that Aetna would not be able to meet such an MCR given the effects the under-pricing was having, and would continue to have, on the quarterly MCRs.
Plaintiff asserts that defendants "shocked the market" on July 27, 2006 by announcing that Aetna's second quarter MCR came in at 81.4% (compared with 78.9% for the second quarter of 2005 - an increase of 2.5 percentage points). In addition, defendants announced that Aetna was changing its full-year MCR guidance again - this time raising it back up to 80%. Defendants note that Aetna's full-year MCR for 2006 was 79.4%.
Plaintiff alleges that these disclosures had an immediate, adverse impact on the market; from July 26, 2006 to July 27, 2006, Aetna's stock dropped from $39.96 per share to $33.25 per share, a decline of $6.71 per share, or almost 17%. The trading volume increased from 5,066,300 on July 26 to 35,884,900 on July 27.
Plaintiff claims that several analysts concluded that under-pricing was in fact responsible for Aetna's higher MCR, including Cowen & Co. which downgraded Aetna stock to Neutral, noting "significant deter. suggests poor medical cost mgmt &/or inadequate pricing." Cowen & Co., "Downgrading Stock on Lack of MLR Visibility," at 1 (July 27, 2006). The Dow Jones newswire reported that Aetna "recorded higher medical costs as a percentage of premium revenue for the second quarter in a row Thursday, prompting concerns that the health insurer has been pricing premiums aggressively in the face of growing competitive pressures in the managed-care industry." According to Merrill Lynch: certain factors are consistent with Aetna having aggressively priced business in 2004-2005. These include more rapid organic enrollment growth than its peers and a subsequent higher-than-expected medical cost ratio in the first half of this year, 'and now a reduction of enrollment coinciding with an expectation that [the MCR] will improve.' Dinah Wisenberg Brin, "Aetna's High Medical Cost Ratio Pressures Shares," Dow Jones News Service, July 27, 2006. An August 21, 2006 article in Barron's noted that FTN Midwest Securities, an institutional equity research firm, had concluded, based upon interviews it conducted with benefit consultants and insurance brokers during September 2005, "that Aetna was being the most aggressive in pricing" national accounts, each of which covered at least 3,000 people. Lawrence C. Strauss, "Healing Aetna," Barron's, August 21, 2006.
Plaintiff also asserts that in February 2006 individual defendants Rowe, Bennett and Callen, but not Williams, sold substantial amounts of Aetna stock at allegedly artificially-inflated prices near Aetna's class period-high stock price. See infra Section III.
II. Alleged Materially False and Misleading Statements
Plaintiff alleges that, throughout the class period, defendants issued numerous false and misleading statements regarding its practice of under-pricing and/or aggressively pricing its accounts at the expense of profitability, resulting in substantially higher than projected MCRs for the first and second quarters of 2006. Plaintiff asserts that the following statements were materially false and misleading and were lacking in reasonable basis at the time they were made.
A. October 27, 2005 Q3 2005 10-Q, Press Release and Earning Conference Call
Plaintiff asserts that Aetna filed its Form 10-Q for the third quarter ending September 30, 2005 (the "Q3 2005 10-Q") with the SEC on October 27, 2005. In conjunction with the filing of its Q3 2005 10-Q, Aetna issued the October 27, 2005 Press Release touting its rising operating earnings that were fueled by, inter alia, "strong membership growth." With regard to its Health Care segment, Aetna specifically noted that Q3 2005 operating earnings were $351.3 million, compared with $268.1 million in Q3 2004. Excluding favorable developments of $15 million (after tax) in Q3 2005 and $14 million (after tax) in Q3 2004, operating earnings increased 32.3% to $336.3 million in Q3 2005, from $254.1 million in Q3 2004. According to Aetna, this "increase primarily reflect[ed] growth in revenues from higher membership levels, as well as strong underwriting results and continued general and administrative expense efficiencies."
Plaintiff asserts that defendants also claimed an improving MCR because, excluding favorable reserve developments, its MCR was 79.0 percent in Q3 2005, compared to 79.2 percent in Q3 2004. Commenting on these results, Rowe stated that Aetna's "continued diligence around medical cost management has allowed us to have among the lowest [MCRs] in the industry." Plaintiff alleges that Aetna's shares jumped from an adjusted closing price of $40.76 per share on October 26, 2005 to an adjusted closing price of $44.18 per share by the end of October 31, 2005.
Plaintiff asserts that in an October 27, 2005 Q3 2005 Earnings Conference Call held in conjunction with the filing of Aetna's Q3 2005 10-Q, investors were again falsely assured of Aetna's disciplined pricing practices when Williams stated:
Perhaps the best example of our operational performance is our dedication to disciplined pricing and medical management. Our pricing policy remains consistent and is based on achieving premium yields in line with our forward view of medical cost trend. We continue to exercise pricing discipline across all products and customer market segments for both this year and as we write new business for 2006.
And when asked by Lehman Brothers Analyst Josh Raskin whether there was a change in "pricing dynamics," plaintiff asserts that Williams responded:
No, I think as I said before, . . . the marketplace is a competitive marketplace. It has been and it continues to be competitive. We have, we believe, very strong pricing discipline and our focus on how we design products that add value to customers, and not compete on the basis of price alone.
Later, in response to another analyst on that conference call, plaintiff asserts that Williams stated:
I am not sure I can answer your question directly. But let me say what I think I understand you to ask, which is, one, we are pricing very clearly in line with our medical cost trend. Two, that we have a very strong amount of pricing discipline. And because we're in a lot of different segments and geographies, there will be different prices, different product mixes that are appropriate to the needs of each of those.
What we are doing is making certain that we are pricing appropriately as best we can, to be certain that we're meeting our shareholder expectations. We feel very good about what has happened this year, and therefore have given the guidance we have given for '06. Plaintiff asserts that the statements set forth in the October 27, 2005 Press Release and Conference Call were materially false and misleading at the time they were made for at least the following reasons: (1) defendants were not practicing disciplined pricing; (2) defendants were not pricing premiums in line with medical costs; (3) defendants had been under-pricing or aggressively pricing its accounts in order to obtain new membership at the expense of profitability and (4) defendants' under-pricing of new accounts resulted in higher costs and, in turn, a higher MCR. Further, plaintiff asserts that defendants concocted other excuses for the higher MCR while it reduced enrollment or raised premiums to address the problem. As a result, plaintiff alleges that Aetna's statements about its disciplined pricing practices were lacking in reasonable basis when made.
B. February 9, 2006 Q4 Earnings Conference Call and Press Release
Plaintiff asserts that defendants continued to mislead analysts and investors regarding Aetna's practice of under-pricing and its effects on Aetna's MCR into 2006. In Aetna's Q4 2005 Earnings Conference Call on February 9, 2006, Williams stated: "Our pricing discipline is unchanged, with commercial risk premium yield percentage increases projected to be in line with our medical cost trend percentage."
Plaintiff asserts that, in the Q4 2005 Earnings Conference Call, defendants Williams and Rowe also both emphasized that Aetna continued to adhere to its pricing discipline. Rowe stressed Aetna's "disciplined approach to pricing" while Williams emphasized Aetna's commitment to "profitably grow market share and earnings" through "disciplined pricing" and noted that "[o]ur pricing discipline is unchanged.. . ."
In the February 9, 2006 Press Release, plaintiff asserts that Aetna announced its results for Q4 2005, stating that operating earnings, excluding prior-period favorable reserve development, were $1.26 per share, an increase of 38 percent compared to the prior-year quarter, and that "[t]he increase in operating earnings reflect[ed] a 14 percent increase in revenue from strong membership growth, as well as strong underwriting results and continued general and administrative expense efficiencies." Plaintiff also asserts that Rowe boasted that Aetna's "medical membership had grown by 1.1 million" during 2005, and claimed that Aetna continued to "maintain among the lowest medical cost trends in the industry."
Plaintiff asserts that the statements made in the Q4 2005 Earnings Conference Call and the February 9, 2006 Press Release were materially false and misleading at the time they were made for at least the following reasons: (1) defendants were not practicing disciplined pricing; (2) defendants were not pricing premiums in line with medical costs; (3) defendants had been under-pricing or aggressively pricing its accounts in order to obtain new membership at the expense of profitability and (4) defendants' under-pricing of new accounts resulted in higher costs and, in turn, a higher MCR. Plaintiff asserts that as a result the defendants' statements about Aetna's disciplined strategy were lacking in reasonable basis when made.
C. March 1, 2006 2005 Annual Report
Plaintiff alleges that defendants also misled the market concerning Aetna's under-pricing practices when Aetna filed its 2005 Annual Report with the SEC along with its Form 10-K for the year ended December 31, 2005 on March 1, 2006. The 2005 Annual Report stated:
During 2005, we continued to improve our operating earnings, cash flows from operations and financial position. The period of 2002 to 2004 was one of ...