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Fifth Circuit: Plaintiffs Can Rely on Post-Statement Events to Demonstrate That a Statement Was False When Made

06.21.19

(Article from Securities Law Alert, May/June 2019) 

For more information, please visit the Securities Law Alert Resource Center

On May 15, 2019, the Fifth Circuit revived in part a securities fraud action against a company that allegedly made misrepresentations concerning its algorithm for predicting and collecting insurance reimbursements for medical procedures. Masel v. Villareal, 2019 WL 2120536 (5th Cir. 2019) (King, J.). The court found plaintiffs adequately pled the falsity of these statements by alleging that the company “was ultimately unable to collect on the overwhelming majority of claims it billed.” The court determined that “evidence of later events can provide useful circumstantial evidence that a given representation was false when made.”

The Fifth Circuit rejected defendants’ contention that plaintiffs were “attempting to prove fraud by hindsight by pointing to later events in order to shed light on the truth or falsehood of earlier statements.” The court noted that “fraud–by–hindsight issues arise in the context of the scienter factor, not the misrepresentation factor.” The court explained that “[w]here, as here, the representation in question concerned an asset or skill possessed by the defendant (here, an algorithm), the defendant’s failure to perform as promised casts doubt on whether he possessed that skill in the first place.” The court offered the example of a pianist who “represents that he is well-trained and commits to perform Gershwin’s Rhapsody in Blue at a concert some time in the future,” but then “arrives unable to play even Chopsticks.” The court noted that in that hypothetical, it is “highly unlikely that he was a talented piano player to begin with.” Similarly here, the court found the company’s eventual inability to collect insurance reimbursements “allow[ed] for the plausible inference that . . . [the company’s owner] had no algorithm and therefore misrepresented her capabilities when she pitched her investment.”

The Fifth Circuit also deemed actionable the company owner’s representations that she had the ability to generate $50,000 or more per insurance claim, and that she typically collects 50% or more of accounts receivable. The court determined that these statements were not “nonactionable future predictions,” as the district court had found, but instead “relate[d] to the present capabilities of [the company’s] algorithm.” The court explained that the statements “concern[ed] how the algorithm could perform at the time the statement was made” and “how the algorithm had previously performed.”

The Fifth Circuit found plaintiffs adequately alleged the company owner’s scienter with respect to the algorithm–related statements because these representations “were based on metrics and information within her own control.” The court explained that the company owner “had [allegedly] developed this algorithm and used its previously,” and therefore “knew how and whether it would work.”

Although the Fifth Circuit reversed dismissal of claims based on the algorithm-related statements, the court affirmed dismissal of claims concerning the company’s representations that it had “superior” billing procedures and “could generate the highest payouts” for the relevant insurance claims. The court found plaintiffs did not allege “that the statements were false when made.” The court explained that “although the payouts generated by [the company] fell short of what [the company’s owner] represented, this does not mean that these payouts were not ‘the highest’ or that the billing procedures were not ‘superior.’” The court found instructive its prior decision in Employees Retirement System v. Whole Foods, 905 F.3d 892 (5th Cir. 2018).[1] There, plaintiffs asserted securities fraud claims based on a grocery retailer’s representation that its prices were “competitive.” The Whole Foods court found that even if the “prices were not as competitive as advertised, it need not follow that they were not competitive.”



[1] Please click here to read our discussion of the Fifth Circuit’s decision in Whole Foods.