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From Securities Regulation Daily, April 23, 2018

Petition asks whether filing of civil complaint can be a corrective disclosure

By Rodney F. Tonkovic, J.D.

A petition for certiorari asks the Supreme Court to consider whether a complaint in a different suit may constitute a corrective disclosure.In this case, the Sixth Circuit flatly rejected a categorical rule, adopted by many district courts, that the filing of a civil complaint is not a corrective disclosure. The petition argues that the Sixth Circuit's case-by-case approach is deeply flawed and ignores the fact that allegations are nothing more than untested claims. The petition also asks the court to address the relation back of otherwise time-barred claims asserted in an amended complaint by new plaintiffs (Community Health Systems, Inc. v. New York City Employees' Retirement System, April 18, 2018).

Community Health Systems. Community Health Systems (CHS) runs the largest for-profit hospital system in the U.S. In 2011, another medical provider, Tenet Healthcare Corp., sued CHS in an effort to defeat a hostile takeover attempt by CHS. Tenet alleged that CHS stated in its SEC filings that its past successes were due to "superior operating performance" when the actual source of its profits was patient intake practices that essentially defrauded Medicare by unnecessary inpatient admissions. On the day this suit was filed, the price of CHS shares dropped significantly.

The complaint underlying this petition was filed less than a month after the Tenet action and was based largely on the Tenet complaint's public revelation that CHS’s successful track record was attributable to allegedly improper and unsustainable admission practices. The initial consolidated complaint encompassed a period up to just before the filing of the Tenet complaint. In 2015, however, an amended complaint expanded the class to include investors who bought or sold shares for six months after the Tenet suit was filed.

Dismissed and reversed. The district court dismissed the complaint. The court explained that the complaint pegged loss causation on the stock price drop after the Tenet lawsuit was filed. Relying on decisions by the Ninth and Eleventh Circuits, the court held that the filing of a complaint is not a corrective disclosure. The court then held that the claims asserted on behalf of the new class members in the 2015 complaint were time-barred and did not relate back to the 2012 complaint because they alleged a different fraud and corrective disclosure. A Sixth Circuit panel reversed and remanded the district court's holding, finding that the new claims in an amended complaint related back to the original complaint and that it was plausible that the allegations from the other suit constituted corrective disclosures.

Corrective disclosure standard. The petition first raises the issue of the requirements for pleading loss causation through a corrective disclosure. The lower courts, the petition argues, are divided over the legal sufficiency of mere allegations of fraud. A complaint such as Tenet's reveals no truth, only allegations, but the Sixth Circuit's holding suggests that every putative disclosure of new information, no matter what the source, must be evaluated to see if the market could perceive it to be true, the petition maintains. The Sixth Circuit's approach conflicts with decisions by the Ninth and Eleventh Circuits holding categorically that the filing of a civil suit is does not establish liability and thus cannot constitute a corrective disclosure.The petition argues further that the Tenet complaint revealed nothing new to the market. Not only was the "Blue Book" used by CHS available to the public, the Tenet complaint itself admitted that it was based on publicly-available information.

The Sixth Circuit's case-by-case approach is deeply flawed, the petition contends, because allegations are nothing more than untested claims and reveal only the potential for a future corrective disclosure of the truth. The Sixth Circuit was also wrong to apply the "plausibility" standard to this inquiry and to ignore information showing what was publicly available.

Relation back. The Sixth Circuit also held that the claims of the new plaintiffs arose out of the same conduct, transaction, or occurrence as in the original pleading and related back under Federal Rule of Civil Procedure 15(c)(1)(B). The appellate court admitted that the 2015 complaint expanded the class definition, but this was permissible because it "conformed" the class membership to the scope of the fraud as originally alleged. There is a circuit split, the petition explains, with at least three different approaches, over the proper test for determining relation back under Rule 15(c). The petition notes further that most circuits would agree that the Sixth Circuit's more lenient approach is incorrect.

Read the docket. This case, and others pending before the Court, can be referenced in the latest version of the Supreme Court Docket. Cases are listed separately, along with a brief summary of the questions raised and the status of the appeal.

The petition is No. 17-1453.

Attorneys: Gary A. Orseck (Robbins, Russell, Englert, Orseck, Untereiner & Sauber LLP) for Community Health Systems, Inc.

Companies: Community Health Systems, Inc.; New York City Employees’ Retirement System

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