Hughes v. Accretive Health, Inc.

TIFFANY M. HUGHES, individually and on behalf of all others similarly situated, Plaintiff, v. ACCRETIVE HEALTH, INC., MARY A. TOLAN, JOHN T. STATON, and JAMES M. BOLOTIN, Defendants.

Case No. 13 CV 3688

UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF ILLINOIS EASTERN DIVISION

September 25, 2014

Judge Joan B. Gottschall

MEMORANDUM ORDER & OPINION

Accretive Health, Inc. is a Delaware corporation that offers revenue-cycle management service to healthcare providers. Lead plaintiff Pressure Controls, Inc. alleges securities fraud against Accretive and three former executives (CEO Mary Tolan, CFO John Staton, and Controller James Bolotin) under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78(j); SEC Rule 10b-5, 17 C.F.R. 240.10b-5; and Section 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78t(a). Specifically, Pressure Controls alleges that Accretive made material misrepresentations and omissions regarding its revenue and earnings, revenue recognition policies and practices, and certifications attesting to financial statements and internal controls.

Now before the court is the defendants' motion to dismiss for failure to state a claim upon which relief can be granted. For the reasons discussed below, the motion is granted.

I. BACKGROUND

The court accepts all well-pleaded allegations in the amended complaint as true for purposes of the motion to dismiss. See, e.g., Killingsworth v. HSBC Bank Nev., N.A., 507 F.3d 614, 618 (7th Cir. 2007).

A. Accretive's Operations

Accretive is a publicly traded corporation that helps healthcare providers manage their revenue cycle operations, including patient registration, insurance and benefit verification, medical treatment documentation and coding, bill preparation, and collections. As of May 3, 2010, Accretive provided revenue cycle management service to 22 customers representing 59 hospitals and $13.6 billion in annual net patient revenue. Accretive's initial public offering took place in May 2010.

Most of Accretive's revenue comes from a small number of customers, especially large, multi-hospital systems. Accretive entered into master services agreements with these systems and managed service contracts with each hospital within the system. The contracts laid out the services that Accretive would provide, along with the applicable fees. If a hospital wanted Accretive to provide additional services, the parties would execute an addendum to the managed service contract.

Almost 90% of Accretive's revenue comes from net services revenue, consisting primarily of base fees and incentive fees. Base fees come from managing customers' revenue-cycle operations. The managed service contracts allowed Accretive to adjust its base fee due to changes in the scope of services that it provided. Incentive fees depended on the improvement of net revenue yield attributable to Accretive's efforts. Generally, Accretive's contracts with its clients required that net revenue be measured using the "best possible metric" as described in Accretive's prospectus:

Through the use of our proprietary technologies and methodologies, we precisely calculate each customer's improvement in net revenue yield. This calculation compares the customer's actual cash collections for a given instance of care to the maximum potential cash receipts that the customer should have received from the instance of care, which we refer to as the best possible net compliant revenue. We aggregate thesecalculations for all instances of care and compare the result to the aggregate calculation for the year before we began to provide our services to the customer. We receive a share of each customer's improvement in net revenue yield.

(Am. Compl. ¶ 30, ECF No. 54.) The managed service contracts allowed Accretive to adjust incentive fees based on net revenue yield improvements that each customer received throughout the life of the contract. Although base fees represent over 80% of quarterly revenue, they account for a smaller share of operating profit because a large portion of those revenues are reimbursements for the costs of revenue-cycle operations.

From the second quarter of 2010 (the first quarter after Accretive's initial public offering) through the third quarter of 2012, Accretive reported ten straight quarters of earnings growth as measured by non-GAAP adjusted diluted earnings per share. During the same period, Accretive met the market's consensus earnings per share expectations in eight of the ten quarters. Accretive reported net services revenue year-on-year growth for every quarter in 2011 and 2012.

B. Disclosures

On March 8, 2013, Accretive filed a Form 8-K with the Securities & Exchange Commission disclosing that it would restate its historical financial statements for a period of nine quarters, from the second quarter of 2010 through the third quarter of 2012. On November 13, 2013, the Company stated that its restatement investigation had "concluded that the timing of revenue recognition under a significant number of its revenue cycle management agreements was incorrect" and that "correcting the timing of revenue recognition will . . . reflect deferred timing of revenue recognition leading to an increase in deferred revenue or other liabilities reported in prior periods . . . [and] increases in revenue in future periods." (Am. Compl. ¶ 33, ECF No. 54.) In an investor call on the same day, Accretive disclosed that it was reviewing its contractual activities for the previous five years.

C. Alleged Misstatements

Pressure Controls alleges that Accretive charged artificially inflated fees throughout the class period based on statements made by three confidential witnesses.

1. Confidential Witness 1

Confidential Witness 1 (CW1) was a Revenue Cycle Operations Senior Manager from January 2007 through February 2012. CW1 worked at Accretive hospital sites throughout the country and was responsible for managing all aspects of a hospital's revenue-cycle operations. CW1 regularly attended site review meetings with Accretive CEO Tolan and several other members of senior management, and maintained professional and personal connections with other Accretive senior managers throughout the country.

According to CW1, Tolan and other members of Accretive's senior management would direct its employees to review e-mails from customers for any indications of interest in additional services toward the end of fiscal quarters. Accretive would then estimate the revenue stream for such a line of service and book it as an increase in the base fee before any agreement to add the service had been finalized.

CW1 stated that there was little confidence in the integrity of the calculations Accretive used to calculate incentive fees. According to CW1, the calculations required drilling down to a very precise level of data and were very complicated. CW1 stated that Accretive used this fact to its advantage by intentionally manipulating its customers' net revenue yields to charge inflated incentive fees, thereby overstating Accretive's reported operating income. Instead of calculating net revenue yields using the Best Possible metric, Accretive frequently billed customers and recognized revenues based on estimates of incentive fees using the "cash-to-gross" method. Thatmethod measures cash collections against gross revenue and represents a more favorable measurement of Accretive's net revenue yield than the Best Possible metric would.

According to CW1, Accretive charged its customers incentive fees over a three-year period based on estimated net revenue yields that were supposedly increasing under the cash-to-gross method. But subsequent calculations under the Best Possible metric showed that net revenue yields actually decreased during that period.

CW1 stated that Accretive's practice of fraudulently inflating its base and incentive fees began before its initial public offering. CW1 observed the practices as early as 2007 and believes that they became pervasive sometime in 2009. According to CW1, Accretive's Vice President of Revenue Cycle Operations (and CW1's boss) quit around December 2009 in part due to these problems.

According to CW1, two to three years into their managed service contracts, Accretive's customers began to notice that they were not seeing the benefits that they were expecting; taking into account the fees they paid to Accretive, their net revenue yields and revenue cycle operation costs were similar to what they had been before enlisting Accretive's services. Customers began to dispute Accretive's fee calculations two to three years after the practice of charging inflated fees began in 2009 and account receivables suffered as a result.

2. Confidential Witness 2

Confidential Witness 2 (CW2) was Accretive's Revenue Cycle Manager in Birmingham, Alabama from April 2007 through April 2012. According to CW2, Accretive overstated net revenue yield improvements by manipulating which hospital departments and services would be included in the calculations, thus inflating incentive fees. CW2 stated that if a certain department or service typically had lower collection rates than others, Accretive would use somepretext to exclude that department or service from its calculations. For example, Accretive might arbitrarily exclude a hospital's cardiology department because it would negatively impact net revenue yield, but include a different department that had a positive expected impact.

3. Confidential Witness 3

Confidential Witness 3 (CW3) was Accretive's Cost Management Manager from April 2006 through May 2010. CW1 and CW3 both stated that Accretive billed customers and recognized revenue for the entire calculated net revenue yield increase, regardless of what portion of the increase was attributable to Accretive's services. According to CW3, Accretive did not have customer approval to do so.

CW3 stated that when Accretive had to mask that it overbilled its clients, it could give back the inflated fee amount by...