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A federal judge has dismissed a class action securities fraud suit after finding that the “particularity” requirements for pleading a federal securities claim apply not only to identifying the specific statements that the plaintiff claims are false, but also to the “true facts” that the plaintiff relies on to show why the statements were false. Significantly, U.S. District Judge John R. Padova found that securities suits that “rely heavily on confidential sources” to establish those true facts “must contain information describing the time period during which the confidential sources were employed by the defendant corporation, the dates on which they acquired the information they purportedly possess, and the manner in which they had access to such information.” It was on that point that Padova found the plaintiff suing Universal Health Services Inc. fell short. In the suit, lead plaintiff Lloyd Freed claims that UHS improperly accounted for its accounts receivable and under-reported its bad debt reserve levels, which allowed UHS to artificially inflate its publicly reported earnings and assets between July 2003 and February 2004. The suit alleges that UHS’ stock price dropped dramatically when it “admitted” in February 2004 that it had been under-reporting bad debt for several quarters; that it was increasing its bad debt reserves to make up for that; and that, as a result, its earnings would suffer significantly in the first quarter of 2004. But Padova found that while the plaintiff’s lawyers had properly pleaded the specific statements made by UHS that they claim are false, they fell short of the particularity requirements in their pleading the true facts that would prove the falsity of the statements. “The amended complaint does not allege when the confidential sources were employed by UHS, the dates on which they acquired the information they purportedly possess, or how these former employees had access to such information,” Padova wrote in his 29-page opinion in Freed v. Universal Health Services Inc. “The amended complaint, therefore, pleads insufficient facts to support the probability that a person in the position occupied by the confidential sources would possess the information that UHS was experiencing an increase in levels of bad debt during the relevant period,” Padova wrote. Padova began by outlining the plaintiff’s claim that UHS made false and misleading statements in press releases, conference calls between financial analysts and UHS officials, and in its quarterly and annual earnings reports that were filed with the SEC. The “essence” of the plaintiff’s claim, Padova said, is that UHS artificially inflated the price of its stock by issuing public statements that omitted or misstated the facts about its rising level of bad debts and by using accounting manipulations to materially overstate its financial results. UHS owns and operates acute care hospitals, behavioral health centers, ambulatory surgery centers and radiation oncology centers throughout North America and France. The suit alleges that in 2001 and 2002, the overall hospital market sector began to experience a change in the mix of patients, which led to an increasing level of uninsured patients. Even those patients who were insured were becoming responsible for an increasing percentage of health care costs because co-pay charges and deductibles were steadily rising. The suit says many hospitals responded to those trends by increasing their levels of bad-debt reserves. But UHS, the suit alleges, reported that it was not affected by the changes and decreased its level of bad debt reserves from 11.9 percent of revenue to 8.5 percent. In doing so, the suit alleges, UHS acted recklessly and kept its bad debt reserves artificially low by materially understating the amount of bad debt it was experiencing. The suit cites a series of allegedly false statements, beginning with a July 2003 press release in which UHS announced that its net earnings per share had increased by 19 percent in the first half of that year. Later that year, in a conference call with investors, a UHS official said: “We’re not seeing, as some of the other companies have mentioned, a real increase in uninsured or at least uninsured after insurance patients or a difficulty in collecting from those patients.” And at a health care conference in January 2004, the suit says, another UHS official stated that the company’s bad debt ratio had not been increasing at the same rate as its peers because UHS had not experienced a material adverse change in self-pay revenues in its markets or in the collection rates, and that he expected UHS’ bad debt ratios to “remain stable in the near term.” The suit alleges that those statements and others proved to have been false in February 2004, when UHS issued a press release that disclosed a significant increase in its “doubtful accounts” that had “resulted primarily from an increase in uninsured and self-pay patients which unfavorably impacts the collectibility of our patient accounts.” The truly bad news came in March 2004, the suit says, when UHS announced that its earnings for the first quarter were down by 25 percent from the previous year. That news caused UHS’ stock price to plunge 21 percent, the suit alleges. In the fraud claim, the suit alleges that UHS was aware as early as July 2003 that its bad debt exposure was increasing and that the company’s failure to make allowance for the bad debt resulted in an artificial inflation of its operating income. To prove that the statements were false, the suit alleges several “true facts”: that UHS officials were aware that levels of bad debt were steadily increasing; that the company admitted that the increase in its bad debt reserves for the fourth quarter of 2003 was a “catch up” or “true-up” for insufficient bad debt reserves during fiscal year 2003; and that the low levels of bad debt UHS had reported were attributable to “fraudulent accounting practices,” which concealed the true amounts of bad debt UHS was encountering. To back up those allegations, the suit cited numerous unnamed former employees of UHS, sometimes including direct quotes, such as a hospital executive who said there are “no surprises or sudden changes” when it comes to bad debt levels because it is known at the point of service whether a patient is uninsured, and because any indicators for potential bad debt problems would appear in reports submitted to UHS corporate offices for monthly management meetings. Padova found that by relying on confidential sources without explaining how they knew the information they provided, the “true facts” alleged in the suit fell short of the particularity requirement of the Private Securities Litigation Reform Act. “Though all of these sources were employed in local UHS hospitals, the amended complaint fails to allege how they would have had access to information regarding UHS’ operations nationwide,” Padova wrote. “Where a complaint relies heavily on former employees who worked in the defendant corporation’s local branches for information concerning the defendant corporation’s business on a national scale, a lack of allegations regarding how or why such employees would have access to the information they purport to possess is problematic,” Padova wrote. The suit also “fails to allege at what time the confidential sources were employed by UHS, or the dates on which they acquired the information they purportedly possess,” Padova found. As a result, Padova concluded that the suit “pleads insufficient facts to support the probability that a person in the position occupied by the confidential sources would possess information regarding UHS’ nationwide operating procedures.” Padova dismissed the suit but ruled that the plaintiff may refile in 60 days if he can cure the pleading deficiencies. None of the lawyers on the plaintiffs’ team could be reached for comment Thursday. The plaintiffs’ team is led by attorney Deborah R. Gross of the Law Offices of Bernard M. Gross, along with attorneys William S. Lerach, Laura M. Andracchio and Susan G. Taylor of the San Diego office of Lerach Coughlin Stoia Geller Rudman & Robbins, and Samuel H. Rudman, Robert M. Rothman and David A. Rosenfeld of Lerach Coughlin’s Melville, N.Y., office. UHS is represented by attorney Neil G. Epstein of Eckert Seamans Cherin & Mellott in Philadelphia, along with James Nespole and Glen Banks of Fulbright & Jaworski in New York.

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