Sec. & Exch. Comm'n v. Wilcox

663 F.Supp.3d 146

SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. Jonathan L. WILCOX, et al., Defendants.

Civil Action No. 22-10651-NMG

United States District Court, D. Massachusetts

Signed March 23, 2023

Jonathan Brian Austin, Pei Yuan Chung, Peter Lallas, Christopher Mark Bruckmann, Securities and Exchange Commission (DC), Division of Enforcement, Washington, DC, for Plaintiff.

Matthew N. Kane, Donnelly, Conroy & Gelhaar, LLP, Boston, MA, for Defendant Jonathan L. Wilcox.

John F. Sylvia, Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C., Boston, MA, for Defendant Jason M. Boucher.

Jonathan L. Kotlier, Ashley M. Paquin, Nutter, McClennen & Fish, LLP, Boston, MA, for Defendant Karen J. Smith.

MEMORANDUM & ORDER

GORTON, United States District Judge

This case arises out of the revenue recognition and accounting practices of a dialysis services company, American Renal Associates Holdings, Inc. ("ARA"). The Securities and Exchange Commission ("the SEC" or "the Commission") alleges that three, high-level employees of ARA, Jonathan L. Wilcox ("Wilcox"), Jason M. Boucher ("Boucher") and Karen J. Smith ("Smith") (collectively, "the defendants"), implemented a scheme to make improper and misleading adjustments to ARA's revenue and other financial metrics. The Commission has brought numerous claims against ARA and the individual defendants for violations of federal securities laws and the Sarbanes-Oxley Act for their actions taken during the period from January, 2017 to November, 2018.

Pending before the Court are separate motions to dismiss filed by all three of the individual defendants. For the reasons that follow, all of the motions will be denied in their entirety.

I. Background

A. The Business

ARA is a dialysis services company incorporated in Delaware with a principal place of business in Beverly, Massachusetts. It forms joint ventures with nephrologists at hundreds of clinics in partnerships in which nephrologists provide care to kidney patients and ARA administers the billing, accounts receivable and other matters related to revenue. ARA's securities were registered under Section 12(b) of the Securities Exchange Act of 1934 and traded on public stock markets from April, 2016 until January, 2021, at which time it was acquired by a private equity firm.

The Commission's allegations concern the revenue recognition and accounting practices of ARA during the period from January, 2017 to November, 2018. The three individual defendants each had significant responsibility for those functions during the relevant time period. Wilcox was the Chief Financial Officer of ARA at all relevant times until his resignation in September, 2018. Boucher was the Chief Accounting Officer of ARA until September, 2018, and the Chief Financial Officer at all relevant times thereafter. Smith was ARA's Controller until September, 2018, and the Vice President of Finance at all relevant times thereafter.

ARA received revenue primarily from three sources: 1) public payors such as Medicare, 2) commercial insurers with which it had negotiated contracts for various services, and 3) commercial insurers with which it did not have contracts or agreed-upon rates ("non-contract insurers" or "NCIs"). Because ARA could not be certain of the consideration it would eventually receive from NCIs for the services it had provided to patients, such revenue was considered "variable consideration" under generally accepted accounting principles ("GAAP").

The pertinent GAAP standards required ARA to record an initial estimate of the revenue it expected to receive from NCIs and then update that estimate by the end of each reporting period based upon the resolution of uncertain events such as payment itself and/or other reductions in uncertainty even if payment had not yet been received. Although there are slight differences between the GAAP provisions regarding variable consideration in 2017 and 2018, neither the SEC nor the defendants contend that such changes materially affected ARA's obligations or the import of the Commission's allegations.

When deriving its initial estimate of variable consideration for a given time period (i.e. expected revenue from NCIs), ARA would record the full amount of the customary price for the services it provided but simultaneously record an offsetting "contractual allowance" to account for any reduction in the amount it actually expected to receive. Those initial contractual allowances were based on ARA's experience with the given NCI as well as other factors and the Commission has not raised any issues with respect to that practice.

B. The Alleged Scheme

The SEC does, however, find fault with the way that ARA updated its initial variable consideration estimates by making "topside adjustments" to revenue. The topside adjustment process at ARA generally comprised of Boucher and Wilcox updating consolidated revenue in order to triangulate that amount with other financial metrics such as Days Sale Outstanding ("DSO") and Revenue Per Treatment ("RPT"). Wilcox and Boucher, working closely with Smith and occasionally others, would then allocate that newly adjusted revenue to individual clinics. Although ARA would sometimes conduct what it called "waterfall analyses" by using patient-level data to make revenue adjustments or to record revenue at a particular clinic, it would often forego or even ignore such data in favor of the topside adjustments it had prepared.

DSO is an important metric in industries where there is a lag between the date when services are provided and the date when revenue for that service is received. DSO is computed by determining the ratio of the accounts receivable balance compared to the average revenue in a day over a given time period, thereby allowing companies to determine the average number of days an invoice remains outstanding. A low DSO means fast payment; a high DSO means slow payment.

Based on prior experience, ARA's management expected its DSO at a consolidated and clinic level to be around 40 and proclaimed that number (which was relatively low, i.e. favorable) to prospective clinics considering a joint venture with ARA and in its public financial disclosures. As stated above, ARA made topside adjustments to its consolidated revenue based, in part, upon its consolidated DSO and then allocated that revenue to individual clinics in order to improve their DSOs.

According to the complaint, the essence of the purported scheme was that ARA falsified financial performance information by making improper topside adjustments to revenue and by targeting a predetermined DSO average (and other desirable metrics) instead of undertaking a bottom-up analysis based upon actual revenue data. A multitude of other allegedly improper practices supported those financial manipulations. All of the individual defendants allegedly had important roles in the fraudulent revenue recognition and accounting functions of ARA throughout the relevant period.

The impact of the purportedly wrongful topside adjustments on ARA's financial statements was revealed in September, 2019, after the company published a restatement of its financial statements from 2014 through the first three quarters of 2018 ("the Restatement").¹ The Restatement was the result of an internal investigation prompted by an SEC inquiry and reported that ARA had overstated its net income by more than $17 million (and revenue by over $16 million) in 2017, and, by more than $22 million (and revenue by over $24 million) in 2018.

C. Procedural History

The SEC filed the pending action in December, 2021, in the Southern District of New York, at which time ARA consented to the entry of a Final Judgment against it. Defendant Smith moved to transfer the case to the District of Massachusetts in January, 2022, and defendants Wilcox and Boucher filed declarations in support of that motion. The Commission opposed the motion but the assigned district judge allowed the motion and ordered the case transferred to this district in April, 2022.

The complaint alleges that each of the defendants violated multiple provisions of the Securities Exchange Act of 1934 ("the Exchange Act") and the Securities Act of 1933 ("the Securities Act") and further alleges that Wilcox and Boucher violated the Sarbanes-Oxley Act. Due to the number and complexity of the claims brought by the SEC, this Court established an extended briefing schedule for defendants' motions to dismiss that permitted the SEC to file an enlarged, omnibus opposition and each of the defendants to submit a reply brief.

In June, 2022, the defendants individually moved to dismiss some or all of the claims asserted against them. Wilcox moved for dismissal of Counts I—V, VII, IX, XII, XIII and XV; Boucher moved for dismissal of Counts I—V, VII, IX and XII; and Smith moved to dismiss all of the claims brought against her (Counts I—III, V, VII, IX, X and XII—XIV).

II. Motions to Dismiss

A. Legal Standard

To survive a motion to dismiss under Fed. R. Civ. P. 12(b)(6), the subject pleading must contain sufficient factual matter to state a claim for relief that is actionable as a matter of law and "plausible on its face." Ashcroft v. Iqbal, 556 U.S. 662, 678, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007)). A claim is facially plausible if, after accepting as true all non-conclusory factual allegations, the court can draw the reasonable inference that the defendant is liable for the misconduct alleged. Ocasio-Hernandez v. Fortuno-Burset, 640 F.3d 1, 12 (1st Cir. 2011).

When rendering that determination, a court may consider certain categories of documents extrinsic to the complaint "without converting a motion to dismiss into a motion for summary judgment." Freeman v. Town of Hudson, 714 F.3d 29, 36 (1st Cir. 2013) (citing Watterson, 987 F.2d at 3). For instance, a court may consider documents of undisputed authenticity, official public records, documents...