Massachusetts Retirement Systems v. CVS Caremark Corp. , 716 F.3d 229 ( 2013 )

United States Court of Appeals
For the First Circuit
No. 12-1900
MASSACHUSETTS RETIREMENT SYSTEMS, Lead Plaintiff, CITY OF
BROCKTON RETIREMENT SYSTEM; PLYMOUTH COUNTY RETIREMENT SYSTEM;
NORFOLK COUNTY RETIREMENT SYSTEM,
Plaintiffs, Appellants,
RICHARD MEDOFF, individually and on behalf of all others
similarly situated,
Plaintiff,
v.
CVS CAREMARK CORPORATION; THOMAS M. RYAN;
DAVID RICKARD; HOWARD MCLURE,
Defendants, Appellees.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF RHODE ISLAND
[Hon. Joseph N. Laplante, U.S. District Judge]
Before
Howard, Circuit Judge,
Souter,* Associate Justice
and Torresen,** District Judge.
Douglas Wilens, with whom Robbins Geller Rudman & Dowd LLP,
Joseph A. Fonti, Serena Hallowell, and Labaton Sucharow LLP were on
brief, for appellants.
Lawrence Portnoy, with whom Edmund Polubinski III, Jessica K.
*
Hon. David H. Souter, Associate Justice (Ret.) of the Supreme
Court of the United States, sitting by designation.
**
Of the District of Maine, sitting by designation.
Foschi, Jason M. Spitalnick, Davis Polk & Wardwell LLP, Willliam R.
Grimm, and Hinkley, Allen & Snyder LLP were on brief, for
appellees.
May 24, 2013
HOWARD, Circuit Judge. This is an appeal from the
dismissal of a putative class action for securities fraud against
CVS Caremark Corporation and certain of its current and former
employees. For the reasons below, we vacate the dismissal and
remand the case for further proceedings.
I. Background
Because this appeal involves a dismissal for failure to
state a claim, Fed. R. Civ. P. 12(b)(6), we recount the relevant
facts based on the well-pleaded allegations in the complaint. SEC
v. Tambone, 597 F.3d 436, 438 (1st Cir. 2010) (en banc). At times,
we borrow from the district court's thorough opinion.
A. CVS Merges with Caremark
In November 2006, CVS Corp. ("CVS") and Caremark Rx Inc.
("Caremark") announced that they would merge. At the time, CVS was
the nation's largest retail pharmacy chain, and Caremark was the
nation's second-largest prescription benefits manager ("PBM"). A
PBM administers prescription drug benefits on behalf of employers,
government agencies, labor unions, and other entities, known as
"sponsors," that provide those benefits as part of their health
insurance plans. The sponsors pay fees to the PBM under a contract
for its services, which include managing prescription drug claims
submitted by those enrolled in the plan. PBMs also negotiate the
prices that the sponsors pay to drug manufacturers for their
products, which are then sold either through retail pharmacies
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(like CVS) that have their own contracts with the PBMs, or through
the PBMs' own mail-order pharmacies. By merging, CVS and Caremark
intended to provide services that only a combined retail pharmacy
and PBM could offer, and to leverage their purchasing power to
drive down their costs.
CVS President and CEO Thomas M. Ryan recognized that the
combined company's success would depend on its ability to deliver
quality service. On a conference call with analysts in November
2006, Ryan said that the combined company would "help employers and
plan providers deliver the right drug at the right place at the
right time." At a March 2007 conference, Ryan stated,
No one is going to have a lower cost structure
than this combined company. No one is going
to be able to out-cost us in the market when
we go. So, then it's all about, okay, what
about service, what about product? And we
think we can out-service and out-sell our
competition here.
Ryan reiterated the importance of service on a May 2007 earnings
call with analysts:
I guess the two things that [plan sponsors
are] most concerned about, one is that there's
no degradation of service. That's the first
thing. And they want to get calmed down that,
as I said earlier, that we're still going to
focus on execution and service and we're
confident that we are.
To provide effective service, CVS would have to integrate
the computer systems of its own proprietary PBM, PharmaCare, with
Caremark's. A failed integration could cause mistakes in the
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pricing and delivery of drugs. One analyst expressed "serious
concerns about the 'merger of equals' structure of the transaction
and the heightened integration risk, given that both companies
themselves have been active industry consolidators in the recent
past." In 2004, Caremark had become the then-largest PBM by
merging with AdvancePCS, which itself was the product of a merger.
According to a confidential witness, Caremark had a "myriad of
systems, they basically let them be autonomous, and had tons of
different systems so they didn't all talk to one another."
Nevertheless, a few days before CVS and Caremark shareholders
approved the merger, Ryan expressed confidence about the prospects
for integration:
Integration planning is on the way . . . .
Caremark has done a lot of these. PharmaCare
is relatively small. I don't mean to diminish
any integration because there's always risk,
but it's relatively straight-forward . . . .
CVS and Caremark completed their merger in March 2007,
creating CVS Caremark Corporation ("CVS Caremark"). Ryan became
the President and CEO of CVS Caremark; David Rickard, who had been
the Executive Vice President and CFO of CVS, retained these titles
at the merged company; and Howard McLure, who had been the Senior
Executive Vice President and COO of Caremark, became the President
of Caremark Pharmacy Services, a division of CVS Caremark.
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B. Misrepresentations About Service and Integration
After the merger, Ryan claimed that CVS Caremark had
integrated its computer systems, was providing excellent service,
and was maintaining its client base. In November 2007, Ryan said
that he was "pleased that we've completed the integration of both
the organization and back end systems quickly and successfully."1
On a conference call with analysts on October 30, 2008, the first
day of the class period, Ryan stated, "Even in these difficult and
uncertain times . . . our PBM continues to retain existing clients
and attract new ones. We will continue to gain share because . . .
[w]e have excellent service." Ryan acknowledged that CVS Caremark
had lost some major clients, but he said that new business would
roughly offset the losses: "For 2009 revenue impact perspective,
the wins and losses are in fair balance." In the following days,
analysts reacted positively to the prospects of CVS Caremark's PBM
business.
In January 2009, Ryan stated on an earnings guidance call
that CVS had secured many of its "2009 wins" because it "repriced
a significant amount of business" in order to take certain "key
accounts . . . off the table and reprice early for all the reasons
1
This statement, like some others mentioned here, predates
the beginning of the class period on October 30, 2008. The
plaintiffs claim that this statement was false, but they do not
include it in the list of alleged misrepresentations upon which
they base their causes of action. Therefore, we recount such
statements to give context to the alleged misrepresentations that
were made during the class period.
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that you can imagine." This repricing included discounts not only
on contracts that were up for renewal, but also on contracts that
were set to expire in 2010 and beyond. According to Ryan, "over
half of our PBM business received improved pricing and close to 70%
of our national accounts were repriced." Reacting to this news, an
analyst asked Ryan, "Is there a concern about the service for the
systems and how can you get people past that also for 2010?" Ryan
denied that concerns about service caused the repricing, stating
that there were "[n]o trade-offs because of our service" or "hidden
agenda here about giving a lower price because of lack of service."
Another analyst asked Ryan whether CVS Caremark's systems "are able
to talk to each other." Ryan responded, "All the systems are able
to talk to each other . . . . We have got no issue with our
systems." Again, analysts reacted positively to the prospects of
CVS Caremark's PBM business.
CVS Caremark continued to proclaim good news as 2009 wore
on. During another earnings call in February 2009, Ryan stated
that in 2008, CVS Caremark's PBM business "had an excellent client
retention and achieved all time industry sales and new business
growth . . . . So for anyone wondering if our offerings are
resonating they certainly are." CVS Caremark's Form 10-K for its
2008 fiscal year, filed later that month, struck a similarly upbeat
tone: "We believe the breadth of capabilities resulting from the
Caremark [m]erger are resonating with our clients and contributed
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to our success at renewing existing clients and obtaining a
significant number of new clients in the 2008 selling season."
Rickard, the Executive Vice President and CFO of CVS Caremark, used
similar language during a meeting with institutional investors on
March 10, 2009, telling them that "our model is resonating in the
PBM marketplace." Rickard further stated that "we have done the
things strategically that needed to be done to make this merger
successful." In two presentations to analysts in May, Ryan stated
that "[a]s far as the 2010 pipeline . . . we're essentially on
plan, in good shape," and reiterated that "[w]e are exactly where
we need to be from a re-upping contract standpoint. So from the
PBM side of our business, we're in good shape." On the company's
earning conference call in August, Ryan forecasted earnings for
2010: "I would be very disappointed if we didn't have an [earnings
per share] growth of at least 13 to 15% next year." Glowing
reports from analysts followed Ryan's statements.2
C. The Truth About the Merger
The complaint alleges that all of these statements
concealed that the merger was, in fact, a disaster. According to
confidential witnesses, problems with the integration of computer
2
For example, in May 2009 an analyst from Deutsche Bank
maintained a "Buy" rating for CVS Caremark and wrote that
"management outlined the recent successes of CVS' unique drug
retail/PBM model and cleared up lingering misinformation about how
the model works and delivers value to payers, patients, and
shareholders."
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systems following the merger caused mistakes that contributed to
the loss of major clients. Three of these clients were worth
$3 billion in annual revenue to CVS Caremark: Coventry, Horizon
Blue Cross Blue Shield of New Jersey ("New Jersey"), and Chrysler.
CVS Caremark lost its Medicare Part D, or "Med-D"
business with Coventry in 2008,3 and the remainder, known as the
"commercial business," followed in 2009. In 2008, Rickard claimed
that the loss of the Med-D business was "due in large part to
price." But according to a former CVS Caremark employee, problems
with the integration of computer systems often resulted in CVS
Caremark representatives being unable to access participants'
information. Participants also complained that they were told that
they would receive a prescription drug at a certain price, but they
would be given a more expensive substitute without their consent.
Another former employee said that the failed computer integration
and high employee turnover resulted in a "nightmare" with Coventry.
CVS Caremark knew no later than October 2008 that it would be
losing Coventry's commercial business, but it did not inform
investors until May 2009.
CVS Caremark considered its contract with New Jersey to
be "at risk" as early as the fourth quarter of 2007. Because it
had failed to integrate its computer systems, CVS Caremark "had 'no
3
Medicare Part D provides partial coverage for prescription
drugs to Medicare beneficiaries. First Med. Health Plan, Inc. v.
Vega-Ramos, 479 F.3d 46, 48 (1st Cir. 2007).
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information on their formularies [i.e., the list of drugs available
under a sponsor's plan], no information on their drug costs,'
resulting in the denial of participant benefits," according to a
former employee. In May 2008, CVS Caremark provided New Jersey
with an "Error Report" that contained approximately 11,000 records.
By the time these errors were substantially resolved, 10,000 more
had occurred.4 In August 2009, CVS Caremark lost New Jersey's
business.
Chrysler had been a client of Pharmacare, CVS's previous
in-house PBM. After the merger, CVS Caremark employees had to
resort to manual data entry to get the participants' correct
information into its systems, and service failures relating to the
merger led to contentious meetings between the two companies. At
one point, the friction was so severe that Ryan himself felt
compelled to participate in a teleconference with Chrysler. As a
result, CVS Caremark knew no later than mid-2008 that Chrysler was
at risk for loss. CVS Caremark announced in August 2009 that it
had lost a portion of Chrysler's business.
D. CVS Caremark Discloses the Truth
On November 5, 2009, the same day that CVS Caremark
reported its earnings for the third quarter of 2009, Ryan
participated in another call with investors. Ryan noted that
4
Former employees state that CVS Caremark had similar
problems with other clients, with groups of as many as 40,000 plan
participants going months without appropriate medication.
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CVS-Caremark's PBM business had suffered "some big client losses"
totaling $4.5 billion. He explained that "approximately two-plus
billion of those came . . . since the [August] call."
Specifically,
I think you know about obviously the State of
New Jersey. This was a bid that the state
wanted on a stand-alone basis, so it was a
kind of price and carve-out issue. We lost
the State of Ohio and the managed Medicare
business. It was carved in, which is about
500 plus million [dollars]. And then we had
another 600 million [dollars] miscellaneous.
These were basically smaller clients . . .
that just really wanted essentially smaller
PBMs. So in total, that was about $2 plus
billion since the last call.
And then, lastly, we had $1.7 billion that we
lost in Med-D business . . . . So net-net,
it's about $4.8 billion in loss . . . for 2010
and approximately almost [$]3.7 billion since
the last call. If you look at the losses,
total the losses with the Med-D and the $4.5
billion contract losses they really come from
four contracts plus . . . Med-D . . . . The
two really that I mentioned and then Chrysler
and Coventry.
Discussing CVS Caremark's financial performance, he stated:
[During the August analyst call] I also said
I'd be disappointed if we didn't have an
[earnings per share] growth of at least 13 to
15% next year for the enterprise. To get to
that 13 to 15% growth rate, I expected strong
double-digit growth in our retail business,
which I still do, and I expected low-to-mid
single digit [growth] in our PBM business,
which is not going to happen. What's changed?
Well, as I just said, we lost more PBM
business than we expected since the [August]
call, $2 billion in contracts. . . . Given all
of that, it now looks like operating profit in
the PBM will decline in 2010, perhaps as much
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as 10 to 12%. . . . 10 percentage basis points
[sic] of the change is Med-D alone.
Ryan also announced the unexpected retirement of Howard McLure, who
was the President of Caremark Pharmacy Services and, according to
Ryan, "one of the chief architects of [the CVS Caremark] integrated
model."
Later in the call, a market analyst asked Ryan, "why, in
the long run, you're still optimistic about . . . the combined
model? And maybe sort of what's gone wrong in the last year or two
and why you think that's going to get better in the next year or
two?" In response, Ryan acknowledged "some big losses," including
"Coventry, which--we lost the Med-D business, and then we obviously
expected to lose the commercial business," and "Chrysler, we lost
the retirees [as opposed to Chrysler's active employees]. It's the
smallest piece of it. It went to where Ford and General Motors
were, with Michigan Blues," i.e., Blue Cross Blue Shield of
Michigan. Ryan added, "[I]f you look at these contracts that we
lost, none of them were because of the model. There were varying
reasons[:] some price, one service, there were varying reasons, but
none of them because of the model."
At another point in the call, an analyst asked Ryan:
But then you look at the PBM numbers, and it
gives everyone heart palpitations. So number
one is why are people kind of shying away from
Caremark's PBM? If it's not the combined
model, and you kind of said maybe it's--there
must be some reason that you're not proving
you're good enough to stand alone PBM [sic] to
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keep those business [sic]. How do you change
those people's minds?
Ryan replied, "Execution and performance, it's not the
products . . . . Now we have to tweak the marketing message a
little, which we're doing to make sure that it's clear about how
those operate and what those actually are and when they hit and
what the savings are, and the benefit to the payers."
Ryan went on to explain that "some stand-alone issues"
caused the downturn in CVS Caremark's PBM business:
the Coventry piece, when we lost Med-D, we
knew we were going to lose the commercial
business. There were some service issues on
that one. . . . Chrysler, we still keep the
[active employees]. We lost the
retirees . . . . [T]here were a variety of
issues. . . . I will tell you this, we didn't
lose anybody that said, well, because you guys
are combined with a retailer, we're leaving.
None of that.
The complaint alleges that Ryan's statements during this
call amounted to a disclosure of "the truth about [CVS Caremark's]
failure to integrate the merged-entity, which resulted in the loss
of billions of dollars in PBM contracts, and that the CVS Caremark
retail-PBM model had failed to gain acceptance by customers in the
pharmaceutical benefit market." The complaint further alleges that
"investors reacted severely, causing the share price of CVS
Caremark stock to collapse," dropping from $36.15 (the share price
at the close of the market the previous day, November 4, 2009) to
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$28.87 at the close of the market on the day of the earnings call
(November 5, 2009), a total of roughly 20 percent.
To support this allegation, the complaint quotes from
several analyst reports of the earnings call. One report said that
CVS Caremark had "stun[ned] with news of additional PBM
non-renewals" on the call and that the "[s]urprise nature of [this]
disclosure raise[d] credibility issues" for the company's
management, because "the magnitude of the loss was discovered on
the call and not in the [earnings] release." Other reports
observed that the "announcement show[ed] a breakdown in the
Caremark model," since the company's PBM business had "lost $4.5
billion with a retention rate of only 92%," and that CVS Caremark
had "provided undeniable evidence . . . that it has mismanaged the
Caremark acquisition and destroyed shareholder value." One analyst
considered the PBM business worthless for purposes of valuing CVS
Caremark's stock: "We do not consider the value of the PBM segment
in arriving at our price target. We view the PBM as essentially a
free option."
Later statements by Ryan and another CVS Caremark
employee reiterated the contribution of service problems to the
company's performance. At a conference on November 17, 2009, Ryan
stated that although
a number of employers, unions, health plans,
[plan administrators] . . . love our client
service[,] . . . we dropped the ball in some
client service issues that we shouldn't have.
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And we're owning up to it and we're fixing it.
So, that's what happened, and it obviously was
a big one with Coventry because the natural
falloff is we know we're going to lose the
commercial business following it.
According to an article in Bloomberg Businessweek in February
2010, the new President of Caremark Pharmacy Services said that the
PBM business "has five segments that haven't been fully
integrated," referring to CVS and Caremark's PBM businesses and
their predecessors. This statement came more than two years after
Ryan said that he was "pleased that we've completed the integration
of both the organization and back end systems quickly and
successfully."
E. District Court Proceedings
This action was filed in November 2009 in the United
States District Court for the District of Rhode Island against four
defendants: CVS Caremark, Ryan, Rickard, and McLure. In June
2010, the complaint was amended to add new allegations and new
plaintiffs: the retirement systems of the City of Brockton and the
Counties of Plymouth and Norfolk, Massachusetts (collectively, the
"Retirement Systems").5 The Retirement Systems claim that the
defendants made material misrepresentations in violation of
5
In the district court, this case was styled Medoff v. CVS
Caremark Corp., No. 09-cv-554 (D.R.I.). The operative complaint
is the Corrected Consolidated Class Action Complaint, filed on
June 1, 2010. Richard Medoff, an individual who owned stock in CVS
Caremark, was named as a plaintiff in the original complaint but
not in the Corrected Consolidated Class Action Complaint.
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Sections 10(b) and 20(a) of the Securities Exchange Act of 1934
("Exchange Act"), 15 U.S.C. §§ 78j(b), 78t(a), as well as Rule
10b-5 of the Securities and Exchange Commission ("SEC"), 17 C.F.R.
§ 240.10b-5. The defendants moved to dismiss the complaint under
Federal Rule of Civil Procedure 12(b)(6) for failure to state a
claim for relief. The district court granted the motion, holding
that the complaint did not plausibly allege that Ryan's statements
on the November 5 earnings call caused the drop in CVS Caremark's
share price, with one exception: his warning that earnings per
share would not grow at least 13 to 15%, as he had forecasted. The
court held that Ryan's forecast could not form the basis for a
claim against the defendants, however, because it was a protected
"forward-looking statement" under the Private Securities Litigation
Reform Act ("PSLRA"), 15 U.S.C. § 77z-2(c)(1). The Retirement
Systems timely appealed.
II. Analysis
A. Standard of Review
We review de novo an order of dismissal for failure to
state a claim. Tambone, 597 F.3d at 441. In conducting this
review, "we accept as true all well-pleaded facts set forth in the
complaint and draw all reasonable inferences therefrom in the
pleader's favor." Artuso v. Vertex Pharm., Inc., 637 F.3d 1, 5
(1st Cir. 2011) (citing Tambone, 597 F.3d at 441). "To survive a
motion to dismiss, a complaint must contain sufficient factual
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matter, accepted as true, to 'state a claim to relief that is
plausible on its face.'" Ashcroft v. Iqbal, 556 U.S. 662, 678
(2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570
(2007)). A claim is facially plausible if it is supported by
"factual content that allows the court to draw the reasonable
inference that the defendant is liable for the misconduct alleged."
Id. While "[t]he plausibility standard is not akin to a
'probability requirement,'" it demands "more than a sheer
possibility that a defendant has acted unlawfully." Id. Unless
the alleged facts push a claim "across the line from conceivable to
plausible," the complaint must be dismissed. Id. at 680 (quoting
Twombly, 550 U.S. at 570).
B. Loss Causation
Section 10(b) of the Exchange Act makes it unlawful to
"use or employ, in connection with the purchase or sale of any
security . . . any manipulative or deceptive device or contrivance
in contravention of such rules and regulations as the [SEC] may
prescribe . . . ." 15 U.S.C. § 78j(b). One of these rules is SEC
Rule 10b-5, which prohibits any person from "mak[ing] any untrue
statement of a material fact or . . . omit[ting] to state a
material fact necessary in order to make the statements made, in
the light of the circumstances under which they were made, not
misleading . . . in connection with the purchase or sale of any
security." 17 C.F.R. § 240.10b-5.
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The Supreme Court has identified six elements of a claim
under Section 10(b) and Rule 10b-5:
(1) a material misrepresentation (or
omission);
(2) scienter, i.e., a wrongful state of mind;
(3) a connection with the purchase or sale of
a security;
(4) reliance, often referred to in cases
involving public securities markets
(fraud-on-the-market cases) as "transaction
causation,";
(5) economic loss; and
(6) "loss causation," i.e., a causal
c o n n e c t io n between the material
misrepresentation and the loss.
Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 341-42 (2005) (emphasis
omitted) (citations omitted). Here, the district court focused on
the element of loss causation--whether the Retirement Systems
adequately alleged a causal connection between the defendants'
material misrepresentations and the drop in CVS Caremark's share
price that followed the November 5, 2009 earnings call.
Plaintiffs commonly establish loss causation by
(1) identifying a "corrective disclosure" (a
release of information that reveals to the
market the pertinent truth that was previously
concealed or obscured by the company's fraud);
(2) showing that the stock price dropped soon
after the corrective disclosure; and
(3) eliminating other possible explanations
for this price drop, so that the factfinder
can infer that it is more probable than not
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that it was the corrective disclosure--as
opposed to other possible depressive factors--
that caused at least a "substantial" amount of
the price drop.
FindWhat Investor Grp. v. FindWhat.com, 658 F.3d 1282, 1311-12
(11th Cir. 2011) (footnote omitted). Loss causation is easiest to
show when a corrective disclosure is associated with a drop in
share price. In re Williams Sec. Litig.--WCG Subclass, 558 F.3d
1130, 1137 (10th Cir. 2009).
C. The District Court's Opinion
The district court began its analysis with a statement
that the defendants acknowledged could have caused the drop in CVS
Caremark's share price: Ryan's announcement that the company would
fail to grow its earnings per share by 13 to 15%, as he had
previously forecasted. Such a projection is a "forward-looking
statement" under the PSLRA, 15 U.S.C. § 77z-2(i)(1)(A), and one who
makes a forward-looking statement cannot be liable in a private
action under the securities laws if "the forward-looking statement
is . . . identified as a forward-looking statement, and is
accompanied by meaningful cautionary statements identifying
important factors that could cause actual results to differ
materially from those in the forward-looking statement." Id.
§ 77z-2(c)(1). The court held that because Ryan's projection was
"couched in cautionary terms" and prefaced with cautionary
language, it could not support the Retirement Systems' claims. The
Retirement Systems do not challenge this ruling on appeal.
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The district court then turned to the remaining alleged
misrepresentations and corrective disclosures. The Retirement
Systems had alleged that during the November 5 earnings call,
"investors learned the truth about the Company's failure to
integrate the merged-entity, which resulted in the loss of billions
of dollars in PBM contracts, and that the CVS Caremark retail-PBM
model had failed to gain acceptance by customers in the
pharmaceutical benefit market." The court disagreed that Ryan had
made statements to this effect on the earnings call, citing Ryan's
denials that there was anything wrong with CVS Caremark's business
model, as well as his explanations that the loss of major clients
such as New Jersey and Chrysler resulted from facts specific to
each client. The court acknowledged Ryan's statement that CVS
Caremark had lost the Coventry contract due to "some service
issues," but it pointed out that Ryan did not attribute those
"service issues" to the integration of CVS and Caremark. The court
held that Ryan's statements did not plausibly constitute a
disclosure of CVS Caremark's failure to integrate or to gain
acceptance of its business model.
The district court also examined the extent to which
Ryan's statements on the earnings call merely reflected information
that had been disclosed previously. The Retirement Systems admit,
for example, that Ryan had disclosed months earlier that CVS
Caremark had lost its contracts with Chrysler and Coventry.
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Moreover, the defendants showed that The Providence Journal
newspaper had reported the loss of the New Jersey contract well
before the call. Therefore, the court held, the Retirement Systems
did not allege a plausible theory of loss causation based on CVS
Caremark's lost contracts.
Finally, the district court stated that McLure's sudden
retirement, which the Retirement Systems compare to a firing, could
not have plausibly caused the drop in CVS Caremark's share price.
The court reasoned that when an executive leaves a company due to
fraud or other problems, a drop in the company's share price
results from the underlying reasons for the departure, not the
departure itself. See New Orleans Emps.' Ret. Sys. v. Omnicom
Grp., Inc. (In re Omnicom Grp., Inc. Sec. Litig.), 597 F.3d 501,
513-14 (2d Cir. 2010).
Based on this analysis, the district court concluded that
CVS Caremark's failure to achieve Ryan's earnings forecast was the
only plausible explanation for the drop in its share price.
Because that forecast was a protected forward-looking statement,
the court dismissed the complaint.
D. Loss Causation Revisited
Our review begins with the same question that the
district court addressed: Could Ryan's statements on the November
5 earnings call plausibly have caused the Retirement Systems'
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losses?6 We agree with the district court that one plausible cause
of this loss was Ryan's announcement that CVS Caremark would not
achieve the earnings growth that he had previously forecasted, an
announcement that the Retirement Systems no longer claim as
supporting liability. To allege loss causation here, then, the
Retirement Systems must allege that Ryan's other statements were a
"substantial" cause of their losses. FindWhat, 658 F.3d at 1309;
Hartman v. Gilead Scis., Inc. (In re Gilead Scis. Sec. Litig.), 536
F.3d 1049, 1055-56 (9th Cir. 2008); McCabe v. Ernst & Young, LLP,
494 F.3d 418, 425 (3d Cir. 2007).
The Retirement Systems claim that the November 5 call
revealed two categories of previous representations to be false:
that CVS Caremark's business model had gained acceptance in the
marketplace, and that the company could deliver quality service
because it had fully integrated its back-end systems. As to the
acceptance of CVS Caremark's business model, the complaint does not
allege that clients rejected the idea of a combined PBM and retail
pharmacy. Therefore, the Retirement Systems fail to state a claim
6
It is unclear whether a plaintiff may plead loss causation
with "a short and plain statement of the claim showing that the
pleader is entitled to relief," Fed. R. Civ. P. 8(a)(2), or if
there is a heightened standard akin to the rule that "a party must
state with particularity the circumstances constituting fraud,"
Fed. R. Civ. P. 9(b). See Lormand v. US Unwired, Inc., 565 F.3d
228, 258 (5th Cir. 2009) (applying Rule 8(a)(2)); Katyle v. Penn
Nat'l Gaming, Inc., 637 F.3d 462, 471 (4th Cir. 2011) (applying
Rule 9(b)). Here, the Retirement Systems' allegations are specific
enough that the outcome would be the same under either standard.
-22-
regarding the business model itself. But the complaint does allege
that the defendants misrepresented the success of CVS Caremark's
integration and the quality of its service. According to the
complaint, Ryan told the market that CVS's and Caremark's systems
had been integrated shortly after the merger of the two companies.
Ryan later told analysts that a worrisome repricing of contracts
was unrelated to concerns about CVS Caremark's service, and he
reiterated that CVS's systems were working with Caremark's.
Several facets of the November 5 call, however, revealed that
Ryan's previous statements were misrepresentations. For example,
Ryan admitted for the first time that the Coventry contract was
lost in part due to "service issues," and McLure's sudden
retirement indicated problems with the "integrated model" that he
had built. After the call, analysts understood that CVS Caremark
had mismanaged the acquisition and damaged the PBM business. The
market reacted accordingly, driving down CVS Caremark's share price
by twenty percent. Later statements by CVS Caremark employees
confirmed that the analysts were correct in their assessment of the
problems with the PBM business.
The defendants argue that the complaint nevertheless
fails to plausibly allege loss causation for three reasons. First,
there was no corrective disclosure because Ryan never said on the
November 5 call that there were problems with the integration of
CVS Caremark's systems. Second, the market knew well before the
-23-
call that CVS Caremark had lost its contracts with Coventry, New
Jersey, and Chrysler. Third, the Retirement Systems cannot support
their theory of loss causation with analysts' reactions to Ryan's
statements. We find these objections unpersuasive.
1. Lack of Corrective Disclosure
The district court concluded that the November 5 call
could not have been a corrective disclosure because Ryan did not
state on the call that CVS Caremark had failed to integrate its
systems. In fact, Ryan attributed the company's lost contracts to
stand-alone issues with particular clients. But a corrective
disclosure need not be a "mirror-image" disclosure--a direct
admission that a previous statement is untrue. Alaska Elec.
Pension Fund v. Flowserve Corp., 572 F.3d 221, 230 (5th Cir. 2009);
In re Williams, 558 F.3d at 1140. To be sure, the corrective
disclosure must relate to the same subject matter as the alleged
misrepresentation. FindWhat, 658 F.3d at 1311 n.28; In re
Williams, 558 F.3d at 1140; Lentell v. Merrill Lynch & Co., 396
F.3d 161, 173 (2d Cir. 2005). But a defendant's failure to admit
to making a misrepresentation, or his denial that a
misrepresentation was made, does not necessarily preclude loss
causation. Flowserve, 572 F.3d at 230 ("If a fact-for-fact
disclosure were required to establish loss causation, a defendant
could defeat liability by refusing to admit the falsity of its
prior misstatements. And if a 'complete' corrective disclosure
-24-
were required, defendants could immunize themselves with a
protracted series of partial disclosures." (citation omitted)
(internal quotation marks omitted)).
Instead, the appropriate inquiry is whether the
November 5 call, as a whole, plausibly revealed to the market that
CVS Caremark had problems with service and the integration of its
systems. Four aspects of the call lend plausibility to this theory
of loss causation.
First, Ryan disclosed for the first time that "service
issues" had led to the loss of the Coventry contract, a statement
that the Retirement Systems interpret as an admission that the
failed integration of CVS Caremark was responsible for the loss of
a major client. The district court disagreed with this
interpretation because Ryan did not attribute those "service
issues" to the integration. We believe that the complaint supports
the conclusion that the "service issues" resulted from poor
integration, and that the market could plausibly have drawn this
conclusion. From the time the merger was announced, analysts had
questioned CVS's ability to integrate with Caremark. One analyst
expressed "serious concerns" about "the heightened integration
risk, given that both companies themselves have been active
industry consolidators in the recent past." Shortly after the
merger was completed, Ryan told analysts that the "first thing"
that concerned plan sponsors was the possibility that the merger
-25-
would degrade service. When Ryan announced in January 2009 that
CVS Caremark had repriced half of its business, one analyst asked
if the reason for the repricing was "a concern about the service
for the systems," to which Ryan responded that "there was no hidden
agenda here about giving a lower price because of lack of service."
Given these concerns, it is reasonable to infer that the market
understood Ryan's statement about "service issues" with Coventry to
imply problems with integration, which would have corrected Ryan's
previous statements that the integration had proceeded smoothly.
The complaint bolsters this inference with statements from
confidential witnesses that problems with the merger of information
systems affected CVS Caremark's relationship with Coventry.
Second, the alarm of the market following disclosure of
the magnitude of CVS Caremark's lost business likely reflected an
understanding that something systemic had gone wrong. Although it
was known that CVS Caremark had lost its contracts with Coventry,
New Jersey, and Chrysler, the company had announced the size of
only the contracts with Coventry ($1.4 billion) and Chrysler ($400
million). As Ryan put it, "approximately $2-plus billion" of CVS
Caremark's contract losses occurred after the previous earnings
call. Ryan also told analysts that the PBM business's operating
profit would decline by "as much as 10% to 12%." Asking Ryan about
these results, one analyst said that "it gives everyone heart
palpitations." The only systemic failure likely to produce these
-26-
numbers and reactions was a failure to integrate the PBM systems,
and when analysts wrote scathing reports in response to the news,
one wrote off the entire value of the PBM business for purposes of
valuing CVS Caremark's shares.
Third, analysts noticed a wide discrepancy between CVS
Caremark's November 5 earnings press release and Ryan's description
of the PBM business. In the press release, Ryan mentioned "solid
performance in our PBM" in the third quarter of 2009, but he waited
until the call to disclose that CVS Caremark had lost billions of
dollars of PBM business since the previous quarterly earnings call
in August. One analyst reacted to the discrepancy by writing that
"the magnitude of the loss was discovered on the call and not in
the release. Surprising market participants with bad news on an
earning call tends to lead to questions about credibility with
respect to everything from earnings guidance to the business model
itself."
Fourth, McLure's retirement alerted the market to
problems with the PBM business. McLure was the President of
Caremark Pharmacy Services, and according to Ryan, he was a "chief
architect[] of [the] integrated model." The retirement came as a
surprise, and it occurred before CVS Caremark had found a
successor. One analyst wrote that "the suddenness of the
retirement of Howard McLure, Caremark's President, leads us to
-27-
believe that his departure was not exactly voluntary . . . . What
this means for future business retention is uncertain."
Perhaps the market did not perceive every detail of CVS
Caremark's struggles, but it knew enough to drive down the price of
CVS Caremark shares by 20%.7 The Ninth Circuit addressed a similar
situation in Sparling v. Daou (In re Daou Systems, Inc.), 411 F.3d
1006 (9th Cir. 2005), in which a company had concealed that it was
using an improper technique to recognize revenue prematurely.
Eventually the company revealed that it had a high level of
unbilled receivables, which the plaintiffs alleged was the result
of this improper technique. Id. at 1025-27. The price of the
company's stock dropped sharply, although the market did not know
the exact reason for the high level of unbilled receivables; one
analyst said that "[w]hen you say one thing on the conference call
and report something different on the [quarterly financial report],
that raises concern. . . . You have got to question whether they
are manufacturing earnings." Id. at 1026. The company later
confirmed that it had improperly recognized revenue. Id. The
court concluded that the plaintiffs' allegations were "sufficient
to provide [the company] with some indication that the drop in
[its] stock price was causally related to [its] financial
7
If this case proceeds, it will be up to the Retirement
Systems to prove how much of this drop resulted from revelations
about CVS Caremark's integration, which are actionable, and how
much resulted from disappointment in CVS Caremark's projected
earnings, which is not actionable.
-28-
misstatements reflecting its practice of prematurely recognizing
revenue before it was earned." Id. (citing Dura, 544 U.S. at 347).
We agree with the Ninth Circuit's approach, and we believe that the
result here is the same. The Retirement Systems' allegations
indicate that the drop in CVS Caremark's share price was causally
related to its misstatements regarding the integration of CVS and
Caremark, and these allegations are sufficiently plausible to
foreclose dismissal.
2. Public Knowledge of Contract Losses
The defendants point out, as did the district court, that
CVS Caremark's loss of Coventry, New Jersey, and Chrysler as
clients was public knowledge well before the November 5 call. In
fact, CVS Caremark had already disclosed the revenue impact of the
lost Coventry and Chrysler contracts. Therefore, the defendants
argue, Ryan's discussion of the loss of these contracts could not
have been a corrective disclosure. See In re Omnicom, 597 F.3d at
512 ("What appellant has shown is a negative characterization of
already-public information. A negative journalistic
characterization of previously disclosed facts does not constitute
a corrective disclosure of anything but the journalists' opinions."
(citations omitted)).
The Retirement Systems respond that their allegations go
beyond the mere loss of these contracts. Instead, they allege that
during the November 5 call, the market learned for the first time
-29-
the real reason for the loss: the failed integration of CVS and
Caremark.8 That information, not the loss of the contracts
themselves, is the corrective disclosure at the heart of the
Retirement Systems' claims. As described above, various aspects of
the call allegedly revealed that the integration had failed: the
identification of "service issues" as a reason for the loss of the
Coventry contract, the first disclosure of the full value of lost
contracts, the discrepancies between CVS Caremark's earnings press
release and Ryan's statements on the call, and McLure's sudden
retirement. Despite the earlier disclosure of CVS Caremark's lost
contracts, this new information could plausibly have caused the
Retirement Systems' losses.
3. Use of Analyst Reports
The district court discounted the complaint's reliance on
analyst reports, stating that the Retirement Systems failed to
"explain how these analysts' remarks, harsh as they were, can serve
to alter the nature of what Ryan actually said during the November
5 earnings call." Although the reports cannot alter Ryan's words,
8
The Retirement Systems also question whether the market was
fully aware of CVS Caremark's loss of the New Jersey contract prior
to November 5, even though the loss had been previously reported in
two articles, one published online and the other in The Providence
Journal. Because the Retirement Systems pleaded the reliance
element of their claims by alleging that the market for CVS
Caremark stock was "open, well-developed, and efficient," meaning
that the price of the stock incorporated available material
information, see Basic Inc. v. Levinson, 485 U.S. 224, 241-42
(1988), they cannot now claim that the market was unaware of
information reported in a major Rhode Island newspaper.
-30-
the Retirement Systems argue that they reflected the meaning of
those words in the market in which they were used. Cf. Stuebler v.
Xcelera.com (In re Xcelera.com Sec. Litig.), 430 F.3d 503, 514 (1st
Cir. 2005) ("[T]he existence of a significant number of analysts
implies that company reports are closely reviewed by investment
professionals, who would in turn make buy/sell recommendations to
client investors." (internal quotation marks omitted)). We agree.9
When a plaintiff alleges corrective disclosures that are
not straightforward admissions of a defendant's previous
misrepresentations, it is appropriate to look for indications of
the market's contemporaneous response to those statements. To
preclude a plaintiff from relying on analyst reports that expose
the limitations of a defendant's statements could permit the
defendant to "defeat liability by refusing to admit the falsity of
its prior misstatements." Flowserve, 572 F.3d at 230. For
example, in In re eSpeed, Inc. Securities Litigation, 457
F. Supp. 2d 266 (S.D.N.Y. 2006), the plaintiffs alleged that
eSpeed, a brokerage company, had concealed that it was alienating
customers and harming its financial performance by allowing some
customers to obtain better trade executions by paying higher
commissions. Id. at 271-76. Following eSpeed's disclosure of
disappointing financial results, an analyst asked its CEO on a
9
The Retirement Systems also contend that the analyst reports
constituted corrective disclosures by themselves, even in the
absence of Ryan's statements. We do not reach this argument.
-31-
conference call whether animosity toward this practice had affected
the company's market share. Id. at 276. The CEO denied this, but
a news article about the conference call, published the next day,
posited a connection between eSpeed's pricing structure and its
poor financial results. Id. at 296-97. The court held that the
CEO's exchange with the analyst, on its own, could not sustain the
plaintiffs' allegations that "disclosure regarding [eSpeed's
pricing structure] was a proximate cause of the economic loss," id.
at 296, but the subsequent article "could establish that, despite
[the CEO's] specific denial, the market understood by the end of
the putative class period what it did not before--that the 'new
fees' or 'new charges' entailed by [eSpeed's pricing structure]
were damaging eSpeed's market share and financial performance," id.
at 297.
Here, Ryan did not admit on the November 5 call that he
had misrepresented the success of the merger, but various aspects
of the call, taken together, plausibly could have alerted the
market that the merger had been unsuccessful. In particular, the
contemporaneous analyst reports could have represented the market's
understanding that the PBM business's poor performance was not a
mere stumble but a signal that the merger had failed to produce any
value for CVS Caremark. Therefore, the analyst reports should have
been considered in deciding the motion to dismiss.
-32-
E. Other Elements of the Retirement Systems' Claims
Although the district court based its decision
exclusively on loss causation, the defendants argue that we can
nevertheless affirm the decision because the Retirement Systems
failed to plead an actionable misstatement or omission by the
defendants.10 While it is true that the failure to plead an
actionable misstatement or omission would support dismissal of the
Retirement Systems' claims, the parties' briefing on this issue is
abbreviated, so we think it best to allow the district court to
consider this argument in the first instance. The same is true for
the scienter element of the Retirement Systems' claims, which was
briefed before the district court but not on appeal. Instead of
reversing the district court's decision, then, we will vacate it to
allow the court to consider alternative grounds for dismissal if it
chooses.
III. Conclusion
For the reasons above, we vacate the dismissal of the
complaint and remand for further proceedings consistent with this
opinion. Costs are awarded to the appellants.
10
For example, the defendants claim that the alleged
misrepresentations were puffery, meaning that they were "too
general to cause a reasonable investor to rely upon them." ECA &
Local 134 IBEW Joint Pension Trust of Chi. v. JP Morgan Chase Co.,
553 F.3d 187, 206 (2d Cir. 2009). In this opinion, we have assumed
without deciding that the Retirement Systems have adequately
alleged the elements of their claims other than loss causation.
-33-