United States: Puffery About Regulatory Compliance Is Not A Material Misstatement

When the blog receives a case that is a bit off-center, involving odd facts or a different area of law, we grab it as our weekly writing assignment. If it's a criminal matter, our claim is premised on our stint as a prosecutor. Today's case is a securities class action, permitting us to relive our days fending off shareholders' actions in the 1980s. Most of those actions were filed by a very, very famous, nay, infamous, plaintiff lawyer in SoCal who ended up in the hoosegow. Every time a company's stock price dropped, it seemed like this guy had a buddy who owned a couple of shares. His firm would tap a couple of computer keys and produce a class action complaint in minutes. The whole thing reeked of sleaze.

Good times.

At least for today, those good times are back, baby. Here is one of the better opening paragraphs in a judicial opinion we have read in a while:

"This case presents us with a creative attempt to recast corporate mismanagement as securities fraud. The attempt relies on a simple equation: first, point to banal and vague corporate statements affirming the importance of regulatory compliance; next, point to significant regulatory violations; and voila, you have alleged a prima facie case of securities fraud! The problem with this equation, however, is that such generic statements do not invite reasonable reliance. They are not, therefore, materially misleading, and so cannot form the basis of a fraud case."

Singh v. Cigna Corp., 2019 WL 102597 (2d Cir. March 5, 2019). The Second Circuit can still occasionally sing when it comes to securities fraud cases. What gave rise to Judge Cabranes's lyricism?

A large health services organization bought a Medicare insurer. With the aging of the health services organization's customers, it looked like a smart play. And, at least for a while, it was. Of course any entity doing Medicare business is subject to extensive federal regulations. The acquiring health services organization not only recognized that fact, it embraced it. Indeed, it not only embraced that fact, it bragged about its regulatory compliance. In the "Regulation" section of the company's 2013 Form 10-K, the company said it "established policies and procedures to comply with applicable requirements." Similarly, in a section titled "Medicare Regulations," the company asserted that it "expect[s] to continue to allocate significant resources" to various compliance efforts. In December 2014, the company published a pamphlet titled "Code of Ethics and Principles of Conduct." The pamphlet includes statements from senior executives affirming the importance of compliance and integrity. The 2014 Form 10-K continued the theme, with a statement that the company "expect[s] to continue to allocate significant resources" to "continue to allocate significant resources" to compliance.

Sadly, as we all know, regulatory compliance can be hard. During the period these statements were released, the company's Medicare operations experienced a series of compliance failures. The government conducted an extensive audit of the company's Medicare operations and, in early 2016, it informed the company that the company had "substantially failed to comply" with regulatory requirements regarding coverage determinations, appeals, benefits administration, compliance program effectiveness and similar matters. The next day, the company filed a Form 8-K disclosing its receipt of the government audit conclusions and the accompanying sanctions.

Then – wait for it (but not too long) – over the next four days, the company's stock price fell substantially.

Then – wait for it (but not too long) – barely a week later, this shareholder class action was filed, alleging violations of federal securities laws. The plaintiff claimed that the statements about regulatory compliance were materially misleading, constituting fraud under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5.

The district court dismissed the complaint for want of materially false statements and scienter. The Second Circuit did not reach the scienter (meaning deceptive intent) requirement, because it was obvious that the statements about regulatory compliance were not materially false. Focus on that word "material." In the securities world, something is "material" if a reasonable stockholder would rely on it in making a decision whether or not to buy or sell stock. Here, the issue is whether a reasonable stockholder would rely on the statements in question "as representations of satisfactory legal compliance" by the company. The answer was a resounding No. A reasonable stockholder would not "consider these statements important in deciding whether to buy or sell shares of stock."

So what? (We envision you asking that question. You are, after all, a bitter and contentious lot.) If you are reading this blog, odds are that you do not do a whole lot of securities litigation. But the notion of materiality is relevant to drug and device litigation. Or, at least, it should be. We might call it causation, but it's really the same thing. It comes down to whether the alleged misstatement truly made any difference. Too many courts presiding over our cases are overly eager to throw the question to the jury as being fact-bound. But if a court in a securities action can indulge in a little bit of common sense, why can't courts in product liability actions? We have seen drug and device plaintiffs allude to statements of regulatory compliance as the bases for fraud claims. But if there's a single consumer out there who decided to ingest a drug or have a device implanted because a company bragged about its regulatory compliance, we will eat our law school Securities casebook.

At this moment we are feeling deeply nostalgic about our days as a securities litigator. That cannot be good.

This article is presented for informational purposes only and is not intended to constitute legal advice.

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