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From Securities Regulation Daily, May 16, 2017

Allegations of recklessly optimistic revenue projections dismissed

By Rebecca Kahn, J.D.

A Massachusetts district court threw out investor allegations that a healthcare IT company deceived them into buying shares at artificially high prices. The alleged misrepresentations of optimistic sales projections in SEC filings and conference calls were non-actionable forward-looking statements. Moreover, the investors failed to adequately allege scienter, given the company’s cautionary statements (Hensley v. Imprivata, Inc. May 15, 2017, Sorokin, L.).

A putative class of investors sued Imprivata, Inc.—an IT security company providing authentication technology for the healthcare and other industries—alleging violations of Exchange Act 10(b) and Rule 10b-5 for deceiving the investors into buying shares at "artificially high prices." The investors named controlling shareholders, officers, and board members as defendants, claiming that from July 30, 2015 through November 2, 2015, in SEC filings, press releases, and in conference calls, the defendants materially misrepresented Imprivata’s sales outlook.

PatientSecure acquisition. In April 2015, Imprivata acquired HT Systems, which makes "PatientSecure," a palm-vein based identification technology. The complaint alleged misrepresentation in (inter alia) a July 29, 2015 press release announcing the acquisition, which made optimistic statements about PatientSecure. In the same release, it announced Q2 2015 earnings and made optimistic sales forecasts. In a conference call on the same day, the CEO said there was increased demand for subscription products and gave optimistic revenue projections, and the CFO said there was tremendous interest in PatientSecure from existing customers.

The investors claimed that these optimistic statements were material misrepresentations. The company allegedly knew the forecasts were unrealistic because demand for IT solutions was on the decline due to an imminent, industry-wide coding transition, competition from other security providers, and industry consolidation at smaller hospitals. The investors further claimed that the CEO knew that demand for IT solutions was on the decline and the CFO also knew that the PatientSecure integration was not ‘on target’ and that its sales outlook was gloomy.

Imprivata’s warnings. Imprivata’s 2014 Form 10-K named specific factors that could cause actual results to differ from its forward-looking statements, including: (1) consolidation in the healthcare industry; (2) decreasing sales to non-healthcare customers; (3) new regulations and changes in pricing for healthcare services, and (4) potential failure in integrating acquisitions, with HT Systems mentioned by name.

Imprivata reiterated these warning in conjunction with its July 31, 2015 Form 10-Q, cautioning about "increased competitive pressure" due to industry consolidation and new market entrants "which could result in the loss of customers or a reduction in revenue." It also warned that because the market for biometric technology was still developing, there was no assurance that PatientSecure would be successful. It further noted that new regulatory interpretations could deteriorate its customers’ financial condition, causing them to spend less on information technology, which could adversely affect Imprivata’s business.

The investors, however, asserted that these risk disclosures were materially misleading and "not sufficiently specific or meaningful," because they failed to disclose that the imminent industry-wide coding revisions would diminish demand for the company’s products. The court disagreed, finding no need for such specificity. Furthermore, the impending coding transition was, by the investors’ own admission, well-known within the healthcare community.

Insider trading allegations insufficient to establish scienter. While insider trading may be probative of scienter, the court ruled that such sales must be "well beyond the normal patterns of trading by those defendants."The investors alleged that controlling shareholders’ sold as much as 40 percent of their total holdings five days after an allegedly misleading July 29, 2015 press release.

Even assuming that the stock sales were suspicious, the court ruled that insider trading cannot establish scienter on its own, but only "in combination with other evidence." Here, the insider trading allegations failed to support a strong inference of scienter given the risk disclosures Imprivata issued two days before the insider sales, the lack of evidence of insider sales by executives, and the dearth of other compelling evidence of scienter.

Moreover, the company issued a press release with preliminary Q3 2015 results and revised its expected quarterly revenue downward. Such a disclosure of financial problems was inconsistent with a high degree of recklessness, the court ruled. In addition, in the four quarters before and three quarters after Q3 2015, Imprivata’s actual Q3 2015 revenue exceeded its maximum projection.

Inadequate allegations of scienter. Even assuming the Q3 2015 revenue projections were not subject to the PSLRA’s safe-harbor provision, the court found that the investors failed to raise a "strong inference" of even the minimum degree of scienter necessary to state a section 10(b) claim (i.e., a "high degree of recklessness"). This was because of Imprivata’s cautionary statements throughout the class period, the vagueness of former employee allegations, inadequate allegations of insider trading, and Imprivata’s early announcement of its Q3 2015 earnings.

The case is No. 16-cv-10160-LTS.

Attorneys: Alessandra C. Phillips (The Rosen Law Firm, P.A.) for Mark Hensley. Alexis L. Shapiro (Goodwin Procter LLP) for Imprivata, Inc.

Companies: Imprivata, Inc.

MainStory: TopStory Enforcement FraudManipulation PublicCompanyReportingDisclosure FormsFilings

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