Zaluski v. United American Healthcare Corp.
2008 U.S. App. LEXIS 11246, 527 F.3d 564, 2008 WL 2167814 (2008)
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Rule of Law:
A company's failure to disclose corporate misconduct and the potential, speculative consequences of that misconduct, such as contract termination by a third party, does not constitute a material omission under Section 10(b) of the Securities Exchange Act, as such consequences are considered non-actionable "soft information."
Facts:
- United American Healthcare Corporation (UAHC), through its subsidiary Omnicare, had a contract with TennCare, a State of Tennessee program, which accounted for nearly 100% of UAHC's revenue.
- The contract (the Contractor’s Risk Agreement or CRA) explicitly prohibited offering gratuities or payments to state officials and allowed TennCare to immediately terminate the contract for such a violation.
- From at least 2001 to March 2005, UAHC made approximately 42 monthly payments of around $10,000 each to Tennessee State Senator John Ford, who sat on committees with TennCare oversight.
- UAHC never sought or obtained approval from TennCare for these payments.
- UAHC did not disclose these payments or the fact they violated the CRA in its public SEC filings during the class period.
- After UAHC publicly admitted to hiring Senator Ford as a consultant, the Tennessee Commissioner of Commerce and Insurance placed Omnicare under "Administrative Supervision" for violating the CRA.
- Following news of the state's action, UAHC's stock price dropped from approximately $5.50 to $2.11 per share.
Procedural Posture:
- Gregory Zaluski and other investors filed a class-action lawsuit against United American Healthcare Corporation (UAHC) in the U.S. District Court for the Eastern District of Michigan.
- The complaint alleged that UAHC violated Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5.
- UAHC filed a motion to dismiss the complaint under Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim upon which relief can be granted.
- The district court granted UAHC's motion to dismiss.
- Zaluski and the other plaintiffs, as appellants, appealed the dismissal to the U.S. Court of Appeals for the Sixth Circuit, with UAHC as the appellee.
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Issue:
Does a company's failure to disclose illegal payments that violate a key contract, and the resulting risk that the contract may be terminated, constitute a material omission of fact that gives rise to liability for securities fraud under Section 10(b) and Rule 10b-5?
Opinions:
Majority - Cole, J.
No. A company's failure to disclose the potential future consequences of corporate wrongdoing, such as the possibility of contract termination by a third party, is an omission of 'soft information' and does not give rise to a duty to disclose under Section 10(b). The court reasoned that there is a critical distinction between 'hard information' (objectively verifiable facts) and 'soft information' (predictions and matters of opinion). While the payments to Senator Ford were hard information, the potential consequences—that TennCare might terminate the contract or impose fines—were speculative predictions dependent on the future actions of an outside party, the State of Tennessee. Unlike cases where a company possesses internal data that directly contradicts its public statements, there was no evidence that UAHC internally believed the contract termination was probable or forthcoming. Therefore, the omission of these potential, uncertain negative outcomes did not make UAHC's other financial statements materially misleading.
Analysis:
This decision reinforces and clarifies the distinction between 'hard' and 'soft' information in securities fraud litigation, thereby narrowing the scope of a company's disclosure obligations. By classifying the potential consequences of known misconduct as non-actionable 'soft information,' the court shields companies from liability for failing to speculate about all possible negative outcomes of their actions. This precedent places a higher burden on plaintiffs to show not only that the company engaged in misconduct, but that it also possessed concrete information making the negative consequences 'virtually as certain as hard facts,' rather than merely possible or foreseeable.
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