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Steiner v. Medquist Inc.

September 29, 2006

WILLIAM STEINER, INDIVIDUALLY HON. JEROME B. SIMANDLE AND ON BEHALF OF HIMSELF AND ALL OTHERS SIMILARLY SITUATED, PLAINTIFFS,
v.
MEDQUIST INC., BRIAN J. KEARNS, DAVID A. COHEN, JOHN A. DONOHOE, ETHAN COHEN, JOHN W. QUAINTANCE, RONALD F. SCARPONE, KPMG LLP AND ARTHUR ANDERSON, DEFENDANTS.



The opinion of the court was delivered by: Simandle, District Judge

OPINION

I. FACTUAL BACKGROUND .................... 6

A. Background ..................... 6

B. Defendants ..................... 7

1. Brian J. Kearns ................ 7 3

2. David A. Donohoe................ 8

3. David A. Cohen................. 8

4. Ethan Cohen .................. 9

5. John W. Quaintance . . . . . . . . . . . . . . . 9

6. Ronald F. Scarpone . . . . . . . . . . . . . . 10

7. Arthur Anderson, LLP . . . . . . . . . . . . . 10

8. KPMG LLP................... 10

C. Billing Scheme .................. 10

D. Billing Disputes ................. 12

E. MedQuist Acquisitions and Philips Merger and Insider Sales....................... 13

F. Material Misrepresentations and Omissions . . . . . 14

G. Audit Reports................... 15

H. Public Disclosures . . . . . . . . . . . . . . . . 16

1. March 16, 2004 Dow Jones Alert . . . . . . . . 16

2. March 24, 2004 Press Release . . . . . . . . . 17

3. March 31, 2004 Press Release . . . . . . . . . 18

4. May 14, 2004 Dow Jones Alert . . . . . . . . . 18

5. May 24, 2004 Press Release . . . . . . . . . . 18

6. June 15, 2004 Press Release Announcing Nasdaq Delisting .................. 20

7. Post-Class Period Disclosures . . . . . . . . 20

I. Procedural History . . . . . . . . . . . . . . . . 21

II. RULE 12(b)(6)

STANDARD OF REVIEW ............ 22

III. DISCUSSION ....................... 22

A. Rule 10b-5 Claims................. 22

1. Materiality ................. 25

a. March 16, 2004 Dow Jones Alert . . . . . 27

b. March 24, 2004 Press Release . . . . . . 28

c. March 31, 2004 Press Release . . . . . . 28

d. May 14, 2004 Dow Jones Alert . . . . . . 29

e. May 24, 2004 Press Release . . . . . . . 29

f. June 15, 2004 Press Release Announcing Nasdaq Delisting . . . . . . . . . . . . 30

2. Misrepresentations or Omissions . . . . . . . 37

3. Scienter................... 47

4. Loss Causation................ 53

B. Rule 10b-5(a) and (c) Scheme Liability . . . . . . 58

C. Section 20(a) Claims . . . . . . . . . . . . . . . 61

D. Auditors ..................... 62

IV. CONCLUSION ...................... 66

MedQuist, Inc. ("MedQuist" or the "Company") is a provider of medical transcription and healthcare information services. In this putative class action under Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934 ("Exchange Act"), Plaintiffs allege a two-part scheme whereby MedQuist, six of its principal officers ("Individual Defendants"), and two of its outside auditors ("Auditor Defendants") (1) manipulated the Company's billing scheme to unlawfully overcharge its customers and underpay its employees for its medical transcription services; and (2) knowingly reported false increased revenues and profits between March 29, 2000 and June 14, 2004 ("Class Period").

Defendants have moved to dismiss the Second Amended Complaint ("SAC") under Rule 12(b)(6), Fed. R. Civ. P., arguing primarily that the Complaint is not pleaded with the requisite particularity under the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. § 78u-4, and Rule 9(b) of the Federal Rules of Civil Procedure. For reasons explained in this Opinion, the motions by the Company and the six Individual Defendants will be denied, and the Court will grant the motions by the Auditor Defendants who will be dismissed from this case.

I. FACTUAL BACKGROUND

In this Rule 12(b)(6) dismissal motion, the Court will, as it must, accept as true the well-pleaded allegations contained in the SAC and consider the documents incorporated by reference therein. See In re Suprema Specialties, Inc. Sec. Litig., 438 F.3d 256, 264 (3d Cir. 2006).

A. Background

MedQuist is a national provider of medical transcription outsourcing and hospital document management services, including digital dictation, transcription, Web-based coding, speech recognition and document delivery systems. (SAC ¶ 33.) In the late 1980's through the early 1990's, senior management at MedQuist instructed personnel to "pad headers and footers" to achieve desired billing amounts. (Id. ¶ 34.) The fraudulent billing scheme became more complex in 1998 when MedQuist began programming ratios and formulas into its various billing systems.*fn1 Using that software, MedQuist "backward billed" its clients by setting the desired revenue profit amount and inflating its customer bills to achieve those results. (Id. ¶ 39.)

B. Defendants

Plaintiffs have alleged securities fraud claims against the Company, six of its principal officers, and two outside auditors retained to conduct independent audits.*fn2

1. Brian J. Kearns

Defendant Kearns was at all relevant times, until his resignation on July 30, 2004, MedQuist's Executive Vice President and Chief Financial Officer. Kearns joined MedQuist as Senior Vice President, Treasurer and CFO on October 16, 2000. Kearns was responsible for managing all accounting, treasury and investor relations functions. (Id. ¶ 21.)

Kearns drafted, prepared, reviewed and signed the Forms 10-Q filed with the Securities Exchange Commission ("SEC") on August 14, 2002, November 14, 2002, May 13, 2003, August 12, 2003, and November 12, 2003, as well as the Form 10-K filed on March 25, 2003.*fn3 Additionally, Kearns signed the Sarbanes-Oxley Act of 2002 certifications attached to these financial statements.

Kearns participated in conference calls on April 23, 2002, July 25, 2002, October 23, 2002 and February 13, 2003 in which the fraudulent billing scheme was discussed. (Id.)

2. David A. Donohoe

Defendant Donohoe served as a MedQuist executive since 1994, first as Executive Vice President of medical transcription, and from 1995 through March 19, 2002 as Chief Operating Officer.*fn4

(Pls. Opp. Br. at 10 n.6) After resigning, Donohoe remained at the Company as an advisor to MedQuist's management team through March 2004. (SAC ¶ 23.)

3. David A. Cohen

David Cohen was MedQuist's Chief Executive Officer and President at all relevant times until his July 6, 2003 resignation. From that date until at least April 4, 2004, Cohen continued his service with the Company as a "Special Advisor" to the Board of Directors. (Id. ¶ 22.)

David Cohen drafted, prepared, reviewed and signed the Form 10-K filed with the SEC on March 25, 2003, which Plaintiffs have alleged contained materially false and misleading statements. Mr. Cohen also signed the Sarbanes-Oxley Act of 2002 certifications on the March 25, 2003 Form 10-K, as well as the Forms 10-Q filed on August 14, 2002, November 14, 2002 and May 13, 2003. (Id.)

David Cohen participated in the April 23, 2002, July 25, 2002, October 23, 2002 and February 13, 2003 conference calls in which the fraudulent billing scheme was discussed. (Id.)

4. Ethan Cohen

Ethan Cohen was serving as Chief Technology Officer of MRC Group, Inc. in December 1998 when that company merged with MedQuist. (Id. ¶ 24.) Mr. Cohen joined MedQuist as its Senior Vice President and CTO in 1998 and served in that capacity until he was promoted to Executive Vice President in October, 2002. Until his resignation on October 31, 2004, Ethan Cohen served as MedQuist's Executive Vice President and CTO. (Id.)

5. John W. Quaintance

Mr. Quaintance was MedQuist's Executive Vice President and Chief Operating Officer until his resignation on January 31, 2005, having joined the Company in 1986. In February 2004, Mr. Quaintance was appointed COO responsible for all activities supporting implementation and delivery of MedQuist's transcription technology and services to its clients. His primary accountability was for profit, customer satisfaction and customer relationships for over 2000 North American customers. Mr. ...


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