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.
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.
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 (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,
Ryan reiterated the importance of service on a May 2007 earnings call with analysts:
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 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,
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.
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."
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 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.
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 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,
CVS Caremark considered its contract with New Jersey to be "at risk" as early as the fourth quarter of 2007. Because it had
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.
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 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,
Discussing CVS Caremark's financial performance, he stated:
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:
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 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 $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."
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
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."
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").
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 matter, accepted as true, to `state a claim to relief that is 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 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, 129 S.Ct. 1937 (quoting Twombly, 550 U.S. at 570). 127 S.Ct. 1955).
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.
The Supreme Court has identified six elements of a claim under Section 10(b) and Rule 10b-5:
Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 341-42, 125 S.Ct. 1627, 161 L.Ed.2d 577 (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
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).
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.
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. 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
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.
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' losses?
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 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 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 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 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
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 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 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%.
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 the real reason for the loss: the failed integration of CVS and Caremark.
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
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 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.
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.
For the reasons above, we
