NORMAN OTTMAN, Plaintiff, IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF MARYLAND SOUTHERN DIVISIO N V. Civil Action No. AW-00-350 8 HANGER ORTHOPEDIC GROUP, INC., IVAL R. SABEL, and RICHARD A. STEIN Defendants. MEMORANDUM OPINION This suit arises out of a securities class action brought by Plaintiffs Norman Ottman, Davi d Chopko, and Gary Backus on behalf of the common stock shareholders of Defendant Hanger Orthopedic Group, Inc. ("Hanger"). Plaintiff also brings suit against Individual Defendants Ivan R. Sabel (Hanger's Chairman of the Board, President, and Chief Executive Officer) and Richard A. Stein (Hanger's Executive Vice-President of Finance and Chief Financial and Accounting Officer). Pending before the Court is Defendants' Motion to Dismiss the Second Amended Complaint [28-1 ]. Plaintiffs have responded and the Motion is now ripe. The Court has reviewed the pleadings and no hearing is necessary. See D. Md. R. 105(6). For the reasons stated below, the Court will GRANT Defendants' Motion to Dismiss. BACKGROUND ' This suit is a securities class action on behalf of investors who purchased common stock of case. The facts are reproduced from this Court's March 29, 200 ~ d~gi n s
Hanger between November 8, 1999 and January 6, 2000 (the "Class Period"). Plaintiffs allege knowing or reckless misrepresentations by Defendants concerning Hanger's financial condition fo r the third quarter of 1999 (ended September 30, 1999) and the status of Hanger's integration o f NovaCare Orthotics and Prosthetics ("NovaCare"), acquired by Hanger on or about July 1, 1999. During the Class Period, Hanger's shares traded as high as $12.50 per share. After January 2000 (following the disclosure of the alleged misrepresentations), the price of Hanger common stock fel l from $9.375 to $3.75 per share, a loss of 60% of the value of the stock in one day and 70% from it s Class Period high. On July 1, 1999, Hanger completed the acquisition ofnovacare for $445 million, more tha n doubling Hanger's U.S. operations. Through the acquisition, Hanger acquired 369 patient care facilities run by NovaCare and hired former NovaCare employees, including certified practitioner s qualified to fit orthotic and prosthetic devices. The acquisition increased the number of patient car e facilities (636), certified practitioners (920), and states covered (42 plus the District of Columbia), as well as the hypothetical combined revenues of the two companies as of March 31, 1999 ($49 2 million). Hanger's acquisition of NovaCare required approximately $430 million and was finance d through a credit facility provided by a syndicate of banks and other financial institutions. Plaintiffs allege, inter alia, that Hanger was concerned about jeopardizing its relationship with its lenders and thus were motivated to conceal any material adverse information about Hanger until after certai n "replacement notes" were registered and sold by institutional purchasers to third parties. Plaintiffs allege the Defendants made materially false and misleading misrepresentations i n two documents: (1) Hanger's November 8, 1999 Press Release and (2) Hanger's quarterly Form 10- Q statement for the three months ended September 30,1999 ("Third Quarter 199910-Q"). Hanger's November 8, 1999 Press Release contained financial results reflecting the NovaCare acquisition an d 2
a statement by Defendant Sabel which said, "We are pleased with the initial results of our efforts t o integrate NovaCare O&P's operations with our operations." The Third Quarter 1999 10-Q, signe d by Defendants Sabel and Stein, reiterated the financial results set forth in the November 8 Pres s Release. Plaintiffs allege that the Press Release and Third Quarter 1999 10-Q materially misrepresented Hanger's revenue in several ways. First, Plaintiff alleges that while Hange r recognized revenue only when a product was delivered to and accepted by a customer, NovaCare recognized income immediately upon manufacture of the orthotic/prosthetic device, without regar d to delivery to or acceptance by the customer. Plaintiff alleges that these different methods fo r recognizing revenue led to an overstatement of Hanger's income during the third quarter and wer e materially misleading in that they were not in accordance with Generally Accepted Accountin g Procedures ("GAAP") Plaintiffs next allege that the November 8 Press Release failed to disclose the number o f orthotics and prosthetics practitioners previously employed by NovaCare who voluntarily cease d employment with Hanger after the acquisition. The loss of a practitioner affects revenue at a rat e of approximately $500,000 per practitioner. Plaintiffs allege that only in January did Defendant s disclose the actual number ofpractitioners who left after the acquisition and acknowledge the "majo r differences in the compensation structures" of Hanger and NovaCare practitioners. Third, Plaintiffs contend that the November 8 Press Release was materially false an d misleading in that it failed to disclose that referral business to Hanger was substantially less than expected after the acquisition of NovaCare. Specifically, Hanger expected that after the acquisition, it would receive two-thirds of the referral sources and that independent providers would receive th e other one-third. However, following the acquisition, referrals to Hanger were only 50%, whil e referrals to independent providers was 50%. Plaintiffs contend that the facts "strongly infer" tha t 3
Defendants' misrepresentations about the level of referrals were made knowingly and recklessly because the importance ofnovacare business to integration means that Hanger would have analyze d and known the level of referral business. On January 6, 2000, Defendants announced that they expected revenue and earnings for the 1999 fourth quarter and 2000 to fall substantially below analysts ' expectations due to: ( 1) the revenue recognition used by NovaCare, (2) the loss of practitioners, and (3) the loss of referral business. Market reaction was swift, and Hanger, which ha d closed at $9.375 per share on January 6, closed at $4.8125 per share the next day. Plaintiffs now bring suit against (1) all Defendants for violations of section 10(b) and Rule lob-5 promulgated thereunder; and (2) against the Individual Defendants for violations of section 20(a) of the Exchang e Act. 15 U.S.C. 78j(b), 78t(a). Jurisdiction exists under 28 U.S.C. 1331. APPLICABLE PRINCIPLES OF LAW It is well established that a motion to dismiss under Rule 12 (b)(6) of the Federal Rules of Civil Procedure should be denied unless it appears beyond doubt that the plaintiff can prove no se t of facts in support of its claim which would entitle it to relief. See Conley v. Gibson, 355 U.S. 41, 45-46 (1957). In determining whether to dismiss the complaint pursuant to Federal Rule of Civi l Procedure 12(b)(6), this Court must view the well-pleaded material allegations in a light most favorable to the plaintiff, and accept the factual allegations in the plaintiff's complaint as true. See Flood v. New Hanover County, 125 F.3d 249,251 (4th Cir. 1997), citingestate Constr. Co. v. Miller & Smith Holding Co., 14 F.3d 213, 217-18 (4th Cir. 1994) ; Chisolm v. TranSouth Finan. Corp., 95 F.3d 331, 334 (4th Cir. 1996) ; J.C. Driskill, Inc. v. Abdnor, 901 F.2d 383 (4th Cir. 1990). In a case involving securities fraud, a complaint must also satisfy the elements set forth i n Federal Rule of Civil Procedure 9 (b), which requires that "[ i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." Fed. R. Civ. P. 9(b) (emphasis added). Pleading with "particularity" requires factual allegations "with regard to 4
time, place, speaker and contents of the allegedly false statement, as well as the manner in which the statement is false and the specific facts raising an inference of fraud." In re Spire Comm 'ns, Inc. Sec. Litig, 127 F. Supp. 2d734,737 (D. Md. 2001 ) (citing Gollomp v. MNCFin., Inc., 756 F. Supp. 228, 232 (D. Md. 1991). Such specificity provides the defendant with fair notice as to the claims an d protects the defendant from public relations and goodwill harm. Id. In addition to the Rule 12(b)(6) and 9(b) requirements, the Private Securities Litigation. Reform Act ("PSLRA") imposes additional pleading requirements on plaintiffs, most notably i n terms of heightening the requirements of Rule 9(b) for pleading scienter." In re Criimi Mae, Inc. Sec. Litig. 94 F. Supp. 2d 652, 657 (4`h Cir. 2000). Under the PSLRA, a complaint must, "`with respect to each act or omission alleged to violate this chapter, state with particularity facts giving ris e to a strong inference that the defendant acted with the required state of mind."' Id. (quoting 1 5 U.S.C. 78u-4(b)(2)). By requiring that a plaintiff state with pa rticularity facts giving rise "to a. strong inference " that a defendant acted with the required state of mind, the PSLRA raises the standard for pleading scienter. In re Ciena Corp. Sec. Litig., 94 F.Supp.2d 650, 657 (D. Md. 2000). The PSLRA does not define "required state of mind" for liability under 10(b) and Rule 1 Ob- 5, and the circuits are split as to what a plantiff must show to prove scienter under the PSLRA. The Fourth Circuit "has not yet determined which pleading standard best effectuates Congress' intent, " but has concluded that "the most lenient standard possible under the PSLRA [is] the two-pronged. Second Circuit test." Phillips, 190 F. 3d at 620-21. Under the Fourth Circuit's Phillips decision, plaintiffs must show that defendants acted with scienter, namely that they "acted intentionally, whic h may perhaps be shown by recklessness." Id. at 620. The Second Circuit test provides that th e requisite "strong inference" of scienter may be established by either "alleging facts sufficient to sho w that defendants had both motive and opportunity to commit fraud or (b) alleging facts that constitut e strong circumstantial evidence of conscious misbehavior or recklessness." Press v. Chem. Inv. 5
Servs. Corp., 166 F.3d 529, 537 (2'Cir. 1999). In contrast, the Ninth Circuit has held that a plaintiff "must plead, in great detail, facts that constitute strong circumstantial evidence of deliberatel y reckless or conscious misconduct." In re Silicon Graphics, Inc. Sec. Litig., 183 F.3d 970, 974 (9`h Cir. 1999 ). Section 20 (a) of the Exchange Act, 15 U. S.C. 78(a), requires that to establish a clai m for controlling person liability, plaintiffs must allege : a primary violation by the controlled person and control and the control of the primary violator by the targeted defendant, and... that the controlling person was in some meaningful sense a culpable participant in the fraud perpetrated by the controlled person. Control over a primary violator may be established by showing that the defendant possessed the power to direct or cause the direction of the management and policies of a person, whether through the ownership or voting securities, by contract, or otherwise. In re Criimi Mae, 94 F. Supp. 2d at 657-58 (quoting SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1472 (2d Cir. 1996)). In order to establish controlling person liability, plaintiff must first state a claim for a primary violation of 10(b) and Rule I Ob-5. Id. In ruling on a motion to dismiss for a. securities class action, a court may consider "public documents quoted by, relied upon, incorporate d by reference in, or otherwise integral to the complaint, and such reliance does not conve rt such a motion into one for summary judgment." In re Spire Comm'ns, 127 F. Supp. 2d at 737 (citing In re MicroStrategy, Inc. Sec. Litig., 115 F. Supp. 2d 620, 623 n.4 (E.D. Va. 2000). DISCUSSION In their motion to dismiss, Defendants maintain that Plaintiffs (1) have failed to plead with particularity any false or misleading statements ; (2) have failed to plead materiality; (3) have failed. to satisfy stringent standards for pleading facts giving rise to a strong inference of scienter ; (4)have failed to plead any basis for bringing a section 10(b) and Rule 10(b)-5 claim against the individual defendants; (5) have failed to state a claim under section 20(a) for controlling person liability. Defendants rely on several District of Maryland class action securities cases in which the Court granted Defendants' motions to dismiss based on failure to state a claim under the rigorous standard s 6
of Rule 9(b) and the PSLRA. See In re Spire Comm 'ns, Inc. Sec. Litig., 127 F. Supp. 2d 734 (D. Md 2001) (Harvey, J.) ; In re Criimi Mae, Inc. Sec. Litig., 94 F. Supp. 2d 652 (D. Md. 2000) (Chasanow, J.) ; In re Ciena Corp. Sec. Litig., 99 F. Supp. 2d 650 (D. Md. 2000) (Motz, J); In re Manugistics Group, Inc. Sec. Litig., 1999 WL 12095909 (D. Md. Aug. 6, 1999) (Smalkins, J.). In each of thes e case, the district court stressed the difficulty of pleading securities class action claims under th e PSLRA. Earlier this year, this Court granted Plaintiffs an opportunity to submit a Second Amende d Complaint that pleads with more particularity, inter alia, the allegations of securities fraud and th e accompanying scienter on the parts of Defendants. As was the case in Plaintiffs' Amended Complaint, the Second Amended Complaint also alleges that Defendants knew about th e discrepancies in revenue recognition between Hanger and NovaCare during the third quarter, bu t presents no facts to substantiate the allegations. In pleading improper revenue recognition, Plaintiff s should allege particular transactions where revenues were improperly recorded, including the name s of customers, the terms of specific transactions, when the transactions occurred, and the approximat e amount of the fraudulent transactions. Plaintiffs have failed to do so. In fact, in its March 29, 2000, opinion, this Court provided Plaintiffs some guidance for writing the Second Amended Complaint. Plaintiffs failed to adhere to those guidelines. Accordingly, this Court finds that Plaintiffs have not. met the threshold requirements for pleading with particularity in a securities class action suit. CONCLUSIO N For the reasons stated above, the Court will grant Defendants' Motion to Dismiss. An Order consistent with this Memorandum Opinion will follow. September 30-112002 w it S`y Alexander Williams, Jr. United States District Judg e 7