(CN) – Shareholders scored a partial victory on appeal of a previously dismissed securities fraud complaint against medical service provider Hanger Inc. and its former CFO George McHenry.
The class, led by the Alaska Electrical Pension Fund, appealed the dismissal to the Fifth Circuit, claiming Hanger and multiple executives committed securities fraud by lying about the results of an audit, forcing the company to restate its financial results after a report by its audit committee.
The district court granted Hanger’s motion to dismiss because the class failed to establish any knowledge of wrongdoing on the part of Hanger and its senior management. Hanger’s orthotic and prosthetic care services were affected in 2010 when Congress expanded on a Medicare audit program. Hanger’s clinics failed to get the correct documentation “in a timely manner,” and faced additional issues under the new audit system, according to the ruling authored by Circuit Judge Jacques L. Wiener Jr.
The expanded audit system saw Hanger fail audits often, and required Hanger to return reimbursements previously collected and Hanger attempted to recover them “via a lengthy Medicare appeals process.”
Despite the problems, the class claims Hanger continued to misrepresent its success to investors.
The pension fund alleges Hanger’s new clinic data management system nicknamed “Janus” caused clinicians to make fewer sales because of the time and resources required to transition to the new system. Hanger allegedly touted the system as having a minimal impact on sales, according to the complaint.
In an investigation filed with the Securities and Exchange Commission, Hanger also discovered their financial health was not as strong as previously indicated.
“Hanger had overstated its accounts receivable and understated its reserves by approximately $40 million,” the fund alleges. “Kirk and McHenry had ‘set an inappropriate ‘tone at the top’ by emphasizing ‘achieving certain financial targets,’ which ‘may have’ contributed to inappropriate accounting decisions.”
The report also concluded that “particular adjustments” were made for the purpose of enhancing Hanger’s reported financial results.
Problems with the Janus system, meanwhile, allegedly caused a 25 percent drop in the value of Hanger’s stock. Later, Hanger announced a delay in releasing its financial statements which caused another 18 percent drop. Following the audit investigation results announcement, the stock fell sharply, down more than 80 percent, shareholders allege.
The district court granted each of the defendants motions to dismiss, citing the class failed to adequately argue any known wrongdoing or scienter.
On appeal, Judge Wiener found that to establish known wrongdoing, appropriate motive must exist. The class argued that the individual defendants intended to artificially inflate the stock value so they could sell at a higher price. The individual defendants argued there existed “a plausible, nonculpable explanation” for selling shares while the stock was tanking, claiming they sold the stock to cover tax expenses as part of a previous trade plan.
While the district court agreed, Judge Wiener found McHenry’s falsified claims concerning the audit were the primary focus of the initial claim as well as the suit against Hanger itself. Wiener upheld CEO Vinit Asar and former CEO Thomas F. Kirk’s motions for dismissal, but reversed and remanded that case against McHenry and Hanger.