Singer v. Reali

883 F.3d 425

Phillip J. SINGER, Individually and on behalf of all other persons similarly situated, Plaintiff–Appellant,

and

Joel Caplin, Individually and on behalf of all others similarly situated, Plaintiff,

v.Kenneth REALI; Joseph P. Slattery; Richard Randall ; Michael Luetkemeyer; TranS1, Inc., Defendants–Appellees.

Phillip J. Singer, Individually and on behalf of all other persons similarly situated, Plaintiff–Appellee,

and

Joel Caplin, Individually and on behalf of all others similarly situated, Plaintiff,

v.Kenneth Reali; Joseph P. Slattery; Richard Randall ; Michael Luetkemeyer; TranS1, Inc., Defendants – Appellants.

No. 15-2579

No. 16-1019

United States Court of Appeals, Fourth Circuit.

Argued: January 25, 2017

Decided: February 22, 2018

ARGUED: Jeremy Alan Lieberman, POMERANTZ LLP, New York, New York, for Appellant/Cross-Appellee. Stephen L. Ram, Aaron C. Humes, STRADLING YOCCA CARLSON & RAUTH, P.C., Newport Beach, California, for Appellees/Cross-Appellants. ON BRIEF: Michele S. Carino, POMERANTZ LLP, New York, New York, for Appellant/Cross-Appellee. John F. Cannon, STRADLING YOCCA CARLSON & RAUTH, P.C., Newport Beach, California; Jonathan D. Sasser, Thomas H. Segars, Kelly Margolis Dagger, ELLIS & WINTERS LLP, Raleigh, North Carolina, for Appellees/Cross-Appellants.

Before KING, AGEE, and FLOYD, Circuit Judges.

No. 15-2579 vacated and remanded, and No. 16-1019 affirmed, by published opinion. Judge King wrote the majority opinion, in which Judge Floyd joined. Judge Agee wrote a dissenting opinion.

KING, Circuit Judge:

These appeals arise from the dismissal of a securities fraud class action complaint in the Eastern District of North Carolina. The action relates to the healthcare provider reimbursement practices of defendant TranS1, Inc., and four officers thereof—defendants Kenneth Reali, Joseph P. Slattery, Richard Randall, and Michael Luetkemeyer (collectively, the "Officers")—in connection with TranS1's AxiaLIF system (the "System"). According to the operative second amended complaint of lead plaintiff Phillip J. Singer (the "Complaint"), TranS1 and the Officers (together, the "Company") conjured up and carried out a scheme that enabled surgeons to utilize the System and secure fraudulent reimbursements from various health insurers and government-funded healthcare programs. The scheme resulted in federal False Claims Act proceedings against TranS1 in the District of Maryland and a fraud investigation conducted by the Department of Health and Human Services (the "DHHS"). On the theory that the Company had concealed the fraudulent reimbursement scheme from the market by way of false and misleading statements and omissions—and that TranS1's stock price dropped precipitously when the scheme was finally revealed—this class action was initiated pursuant to, inter alia, section 10(b) of the Securities Exchange Act.

In dismissing the Complaint with prejudice, the district court concluded that, although the Complaint alleges the loss causation element of the section 10(b) claim, it does not sufficiently plead the material misrepresentation element or the scienter element of that claim. By his appeal (No. 15-2579), Singer seeks reinstatement of the Complaint, contesting the court's rulings on the misrepresentation and scienter elements. TranS1 and the Officers have cross-appealed (No. 16-1019), asserting that the court erred in rejecting their challenge to the loss causation element. As explained herein, we vacate in No. 15-2579 the court's rulings that the Complaint fails to satisfy the misrepresentation and scienter elements, and we affirm in No. 16-1019 the court's ruling that the Complaint sufficiently alleges the loss causation element. Consequently, we remand for further proceedings.

I.

A.

According to the Complaint, TranS1 is a medical device company that first received approval in 2004 to sell the System, which was designed for minimally invasive surgery on the lower lumbar spine to treat degenerative disc disease. See Compl. ¶¶ 2, 25, 27.¹ A System surgery utilizes a "pre-sacral approach"—i.e., the surgery is performed straight up the tailbone, with the patient remaining on her stomach—differentiating it from more common surgeries performed through the anterior portion of the spine. Id. ¶¶ 2, 26. TranS1 derives its revenues almost entirely from sales of the System and related surgical instruments, as well as from a share of the reimbursements made by health insurers and government-funded healthcare programs to surgeons for spinal surgeries using the System. Id. ¶¶ 3, 25. The financial success of the Company largely hinges on surgeons' reimbursement claims being paid, not only because TranS1 receives a share of those reimbursements, but also because, if the reimbursement claims were denied, surgeons "would simply stop utilizing the [System]." Id. ¶ 4.

In this securities fraud class action, the putative class includes those investors in TranS1 who purchased common stock between February 23, 2009, and October 17, 2011—the period in which the Complaint alleges that the Company's fraudulent reimbursement scheme was concealed from the market. See Compl. ¶ 1. Each of the Officers was, in one capacity or another, involved in the management of TranS1 during the relevant time frame.²

The Complaint explains that a healthcare provider submitting a reimbursement claim for a surgery is obliged to use Current Procedural Terminology codes ("CPT codes") promulgated by the American Medical Association (the "AMA"). See Compl. ¶ 4. For spinal surgeries, the AMA generally adheres to the coding recommendations provided by the National Association of Spine Surgeons (the "NASS"). Id. The various CPT codes fall into three categories, which are designated as Categories I, II, and III. Only the Category I and Category III codes are relevant here. A Category I code indicates that a surgical procedure is "traditional" and widely accepted in the medical community, assuring a full or substantial reimbursement. Id. ¶ 6. On the other hand, the use of a Category III code reflects that the procedure is "experimental" and not widely accepted. Id. ¶ 5. A Category III code often results in no reimbursement at all, dissuading healthcare providers from performing Category III procedures. Id. ¶ 6.

Relevant here, the System was initially coded as a Category I anterior fusion procedure and thus garnered a full or substantial reimbursement. See Compl. ¶¶ 5, 29. In February 2008, however, the NASS recommended that the coding for the System be changed to Category III, because the System is unlike traditional anterior fusion procedures and "suffered from a dearth of safety and efficacy data."Id. ¶¶ 5, 30.³ The AMA adopted the NASS recommendation and, effective January 1, 2009, required the System to be coded under Category III. Id.

B.

The Category III coding requirement threatened TranS1's revenue stream and financial viability, in that surgeons could no longer count on reimbursements from health insurers and government-funded healthcare programs for using the System. See Compl. ¶¶ 6, 30. The Complaint alleges that, as a result of the new Category III code, the Company concocted and carried out its multifaceted and sophisticated fraudulent reimbursement scheme. Id. ¶ 7. The crux of that scheme was "to convince surgeons to engage in improper reimbursement practices in direct violation of" various statutes, including the federal False Claims Act. Id. ¶ 31. That is, the Company "encouraged and coached surgeons to utilize alternate codes, instead of the mandated experimental Category III designation assigned to [the System], in order to allow for reimbursement for the procedure." Id.

The Complaint describes the fraudulent reimbursement scheme as it was perpetrated and carried out by the Company. Pursuant to that scheme, the Company on occasion acknowledged the System's new Category III code and some of the difficulty in securing reimbursement for it, but at other times encouraged and instructed surgeons to nevertheless use a Category I code for the System. The fraudulent reimbursement scheme was executed by way of, inter alia, the following:

• The Company formed a reimbursement committee to train surgeons on how to avoid the mandatory Category III code for the System. The head of the committee, a TranS1 employee, gave presentations detailing exactly which non-Category III codes to use and in what manner, and she established a "hotline" for surgeons to call to get coding advice. Pursuant to her instructions, when surgeons did use the Category III code, they were to "bury" it in the reimbursement claim so that the insurer might overlook it. See Compl. ¶¶ 32, 51.

• During conference calls with its third-party product distributors, the Company instructed the distributors to advise surgeons that the System should be coded as a Category I anterior fusion procedure, as it had been prior to the AMA's adoption of the Category III code. In an effort to quell the concerns of surgeons who were aware of the new Category III designation, the Company further advised the distributors to tell such surgeons that "all surgeons" were using a Category I code for the System. Id. ¶¶ 33, 56.

• The Company conducted on-site training sessions designed to encourage surgeons to exchange tips on how to "manipulate" coding to get reimbursed. The most popular site was Cincinnati, Ohio, where TranS1's top consultant gave numerous presentations wherein he coded the System under Category I. Id. ¶¶ 34, 62.

• The Company drafted and distributed a reimbursement guide, dated January 1 through June 30, 2009, for surgeons to use in making successful claims for reimbursement of System surgeries. It was only on the guide's last page that the Company acknowledged the required Category III code for the System and the unlikelihood of reimbursement for Category III procedures. Id. ¶ 35.

• At the behest of the Company, TranS1's top consultant created a template demonstrating how to improperly code the System as a

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