In Re Healthways Inc. Derivative Litigation

In re HEALTHWAYS, INC. DERIVATIVE LITIGATION

No. M2009-02623-COA-R3-CV

COURT OF APPEALS OF TENNESSEE AT NASHVILLE

October 13, 2010

Filed: March 14, 2011

Appeal from the Chancery Court for Davidson County

No. 08-1426-11 Carol L. McCoy, Chancellor

Plaintiff in shareholder derivative action appeals the dismissal of his suit alleging breaches of fiduciary duty and other misconduct, including insider trading, by current and former officers and directors of corporation. Plaintiff filed suit without first making demand on the board of directors of the corporation that the directors initiate the lawsuit. Defendants moved to dismiss the suit on the ground that plaintiff failed to allege with requisite particularity that such demand would have been futile. We affirm the dismissal of the action.

Tenn. R. App. P. 3 Appeal as of Right; Judgment of the Chancery Court Affirmed

RICHARD H. DINKINS, J., delivered the opinion of the court, in which PATRICIA J. COTTRELL, P.J., M.S., and FRANK G. CLEMENT, JR., J., joined.

Paul Kent Bramlett and Robert Preston Bramlett, Nashville, Tennessee; Brett D. Stecker, Jeffrey J. Ciarlanto, and Robert B. Weiser, Wayne, Pennsylvania; and James G. Flynn and Robert I. Harwood, New York, New York, for the appellant, Roy T. Forrest.

Wallace W. Dietz and Brian D. Roark, Nashville, Tennessee; and Brandon R. Williams, John L. Latham, and Susan E. Hurd, Atlanta, Georgia, for the appellee, Healthways, Inc.

opinion

This is an appeal of the dismissal of a shareholder derivative action brought on behalf of Healthways, Inc., a Delaware corporation headquartered in Tennessee. Plaintiff Roy T. Forrest is a Healthways shareholder who filed a shareholder derivative suit against Healthways on June 27, 2008 in Davidson County Chancery Court. On July 24, 2008, a second Healthways shareholder, Nikki Tran, filed a separate shareholder derivative suit, also in Davidson County Chancery Court. On August 19, 2008, an order consolidating the suits was entered and, on May 11, 2009, Mr. Forrest filed a "Consolidated Verified ShareholderDerivative Complaint," naming fifteen current or former officers or directors of Healthways as defendants.¹ The action was filed without plaintiff first making demand on the board of directors of Healthways that the directors initiate the action.

Plaintiff asserted separate causes of action that all defendants breached their fiduciary duty to the corporation by disseminating false and misleading information, by failing to properly oversee and manage the company, and by failing to maintain adequate internal controls; plaintiff also asserted that all defendants unjustly enriched themselves and wasted corporate assets. Plaintiff asserted a further claim against certain of the defendants for breach of fiduciary duties based on insider selling and misappropriation of information. The action sought compensatory damages as well as equitable and injunctive relief.

Defendants moved to dismiss the case on the ground that the complaint failed to allege with requisite particularity that demand on the directors to initiate the action would have been futile. The trial court agreed and dismissed the action. The sole issue on appeal is whether the court erred in finding that Plaintiff failed to plead demand futility with requisite particularity.

I. Factual Allegations of the Complaint²

Healthways is a disease management company that "provides specialized, comprehensive Health and Care Support solutions to help people maintain or improve their health and, as a result, reduce overall healthcare costs." In 2005, Healthways began participating as a provider in the Medicare Health Support Pilot Program ("MHS Program"), an initiative of the Centers for Medicare & Medicaid Services of Health and Human Services ("CMS"). The MHS Program had two primary goals: to improve the quality of medical care received by Medicare and Medicaid beneficiaries who had multiple chronic conditions and to help the Medicare and Medicaid programs achieve cost savings targets.

The program was designed to consist of two phases, the first of which would last three years. During Phase I, CMS would evaluate the care that Medicare and Medicaid beneficiaries received, their satisfaction with the care received, and the cost savings achieved through the MHS Program. Once Phase I ended, CMS would decide whether to expand the MHS Program to a nationally rolled-out Phase II. At the outset of the program, CMS established a 5% cost savings target as a criteria for evaluating the success of Phase I. Underthe terms of Healthways' contract with CMS, failure to meet the 5% per month cost savings target could obligate Healthways to reimburse CMS for millions of dollar in fees that CMS paid to Healthways in connection with the MHS Program; it would also make Healthways' participation in any potential Phase II of the program unlikely.

Plaintiff alleges that, during the period from October 17, 2007 to May 11, 2009, defendants received quarterly "ARC reports"³ from CM S which showed that Healthways was falling short of the 5% per month cost savings target but that, rather than disclose Healthways' inability to meet the Phase I savings target, "defendants instead began lobbying the CMS to lower the MHS Phase I savings targets." On January 7, 2008, Healthways filed a Form 8-K⁴ with the SEC stating that the Office and Management and Budget had approved a request from CMS to lower the savings target for the MHS Program "from 5% net savings to budget neutrality (savings greater than or equal to fees)."⁵ Plaintiff asserted that, after this announcement, Healthways stock increased from $64.50 to $67.21 per share, but that "[t]he price was artificially inflated, as not only were defendants specifically aware that the Company had been failing to meet the 5% cost savings target all along, but also that the Company could not meet the modified break-even savings target." Plaintiff further alleged that on February 26, 2008, Healthways issued a press release announcing that the Company was lowering its financial guidance for fiscal 2008 from a range of $782-815 million to $720-740 million and its earnings guidance per share from a range of $1.77-1.86 to $1.50-1.55 and that, as a result, Healthways stock fell to $31.54, representing a near 30% one-day loss and a decrease of more than 53% since January 7.

Plaintiff charged that communications issued by defendants relative to Healthways' participation in the MHS program were false and misleading⁶ as were components of thefiscal 2008 guidance which allegedly failed to disclose that major Healthways customers, including Blue Cross of Minnesota, Blue Cross of Massachusetts, and WellPoint were cancelling programs and/or requiring Healthways to provide more services for the same or less money with a resulting negative impact on profits.

Plaintiff also alleged that between October 29, 2007 and January 9, 2008 certain of the defendants, whom plaintiff referred to as the "insider trading defendants," sold a total of 288,824 Heathways shares while in possession of material, adverse non-public information and otherwise in violation of the company's Code of Conduct.

II. Applicable Law

Healthways is chartered under Delaware law and, at the time this action was initiated, was headquartered in Nashville, Tennessee; the parties do not contest the exercise of jurisdiction by the Tennessee courts or venue in Davidson County.

Tennessee adheres to the "internal affairs" doctrine, under which matters involving the internal affairs of a foreign corporation are deemed substantive in nature and "should be resolved in accordance with the law of the state of incorporation." Hicks ex rel. Union Pac. Corp. v. Lewis, 148 S.W.3d 80, 84 (Tenn. Ct. App. 2003) (citing Bayberry Assocs. v. Jones, No. 87-261-II, 1988 WL 137181, at *4 (Tenn. Ct. App. Nov. 9, 1988), vacated on other grounds, 783 S.W.2d 553 (Tenn. 1990); Amberjack, Ltd. v. Thompson, No. 02A01-9512-CV-00281, 1997 WL 613676, at *8-9 (Tenn. Ct. App. Oct. 7, 1997). As noted earlier, the sole issue presented in this appeal is whether the complaint alleged facts sufficient to excuse plaintiff from making a pre-suit demand on the Healthways board of directors. In Kamen v. Kemper Financial Services, Inc., 500 U.S. 90 (1991), the United States Supreme Court explained that, in a shareholder derivative suit, any demand requirement or exception thereto, is deemed a matter of substantive law⁷; thus, we apply Delaware law to resolve the substantive issues.

Procedural matters, however, including the standard of review, are governed by Tennessee law. State ex rel. Smith v. Early, 934 S.W.2d 655 (Tenn. Ct. App. 1996); accord 16 AM. JUR. 2d CONFLICT OF LAWS §§ 134-35 ("Matters of procedure... are governed by the law of the forum"). Because this appeal is from the grant of a motion to dismiss and involves a question of law, the scope of our review is de novo with no presumption of correctness. Coulter v. Hendricks, 918 S.W.2d 424, 426 (Tenn. Ct. App. 1995).

III. Analysis

A. Pre-Filing Demand

Pursuant to Delaware law, before a shareholder may initiate a derivative action, the shareholder must present the allegation to the corporation's directors and request that the board bring the suit. Del. Ch. R. 23.1;⁸ Stone v. Ritter, 911 A.2d 362, 366-67 (Del. 2006). If the directors refuse to pursue the action, the shareholder may initiate the suit by showing that the board wrongfully refused to do so. Id. However, when demand has not been made, as is the case here, the complaint is subject to dismissal unless the plaintiff can plead with requisite particularity why it would be futile to make a demand upon the board of directors. Wood v. Baum, 953 A.2d 136, 140 (Del. 2008); see also Stone, 911 A.2d at 366-67.

In order to excuse demand under Del. Ch. R. 23.1, the complaint must plead "particularized facts" creating a reasonable doubt that "the directors are disinterested and independent" or that "the challenged transaction...