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From Securities Regulation Daily, February 27, 2018

Weak scienter allegations sink fraud claim against healthcare company

By Amy Leisinger, J.D.

A California district court has dismissed a securities fraud action against a healthcare company for failure to adequately allege scienter. According to the court, the plaintiff sufficiently alleged that certain statements made by the company regarding a deal with the Venezuelan government were false of misleading but failed to demonstrate that statements of expectations or stock sales by company executives gave rise to a strong inference of scienter (Costabile v. Natus Medical, Inc., February 26, 2018, White, J.).

Venezuelan contract. In late 2015, executives of Natus Medical, a healthcare products and services provider, announced that it had entered into a $232.5 million contract to provide supplies and services to the Ministry of Health of Venezuela and that $69 million in prepayments were expected by the first quarter of 2016. The executives touted the deal on analyst calls and at conferences, stating that prepayments would continue throughout the contract and noting the "ongoing relationship" between the Ministry and Natus’ Argentinian subsidiary. They also noted that risk was "minimal" because the contract was denominated in dollars.

After problems arose, the company described "delays" in the contract and modified its guidance, and, thereafter, its stock price fell. The shareholder plaintiff filed a complaint alleging that there was no enforceable contract at all because it was never executed and that, in the alternative, Natus and the executives failed to disclose that the Ministry failed to make required payments as expected and misled investors by referencing the prior relationship between the company and the government. According to the complaint, the defendants also failed to disclose that Natus had no way to enforce its rights in light of a forum selection clause and were aware that the deal may not last as a result of upcoming elections in Venezuela.

Material misstatement and omissions. According to the complaint, the disclosures of "delays" and "risks" were misleading, as the defendants did not, at the time, disclose that prepayments had been missed and that Venezuelan and Argentinian elections had resulted in "significant political changes." Rejecting the plaintiff’s contention that supply contract was not executed, the court found that the complaint adequately alleged that certain statements were false and/or misleading. When an executive represented that the $69 million prepayment would "start" in 2015 and continue into 2016, he failed to disclose that the contract terms required the entire payment by the end of 2015, a shorter timeframe that would have been significant to a reasonable investor, the court explained. Further, the court continued, the complaint sufficiently demonstrated that the statements regarding the first prepayment were misleading because they omitted to state that the Ministry was required to make prepayments in late 2015. These statements were not protected "forward looking" statements because the stated "expectation" related directly to existing contract terms, according to the court.

The complaint also plausibly alleged that the statements regarding the restatement of increased revenue guidance were materially false or misleading, the court determined. However, the court found, the complaint failed to provide sufficient detail to demonstrate that the statements regarding the company’s relationship with the Ministry were misleading.

Scienter. The court found that, on the whole, the complaint failed to plead facts giving rise to a strong inference of scienter. While the statements that the prepayment was "expected" by the end of 2015 were plausibly misleading because of the failure to disclose the lack of payment, the complaint did not demonstrate any facts supporting an inference that the statement was made deliberately recklessly or intended to mislead. Further, the statements give rise to a competing inference that they were only made with regard to a "then-held belief" concerning when payment would be received, the court noted. The allegations concerning the timing of the executives’ Natus stock purchases also failed to support a finding of scienter, as their prior trading histories undercut any inference of scienter and do not appear suspicious, the court concluded.

Because the complaint failed to adequately plead an underlying fraud claim, the court also dismissed its controlling person claim. The court granted leave to amend before April 6, 2018.

The case is No. 17-cv-00458-JSW.

Attorneys: Kara M. Wolke (Glancy Prongay & Murray LLP) for John Costabile. Kevin Peter Muck (Fenwick & West LLP) for Natus Medical, Inc.

Companies: Natus Medical, Inc.

MainStory: TopStory FraudManipulation CaliforniaNews

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