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Securities – Medical reimbursement scheme was material omission

Holding: Investors’ complaint against a medical device company sufficiently alleged violations of § 10(b) of the Securities Exchange Act, claiming that the company’s officers knowingly misrepresented material facts constituting a fraud on the market.


Appellee TranS1 received approval in 2004 to sell its AxiaLIF system, a medical device for spinal surgery. TranS1 derives its revenues almost entirely from sales of the system and related surgical instruments, as well as from a share of the reimbursements made by health insurers and government-funded healthcare programs to surgeons for spinal surgeries using the system. The financial success of the company largely hinges on surgeons’ reimbursement claims being paid, not only because TranS1 receives a share of those reimbursements, but also because, if the reimbursement claims were denied, surgeons would simply stop utilizing the system.

Healthcare providers submitting reimbursement claims for surgery are obligated to use codes promulgated by the American Medical Association. For spinal surgeries, the codes fall into three categories, designated as Categories I, II, and II. A Category I code indicates that a surgical procedure is widely accepted in the medical community, assuring a full or substantial reimbursement. By contrast, a Category III code reflects that the procedure is “experimental” and not widely accepted. Thus, Category III coding often results in no reimbursement at all, dissuading healthcare providers from performing those procedures.

The AxiaLIF system was initially coded as a Category I procedure and, thus, garnered a full or substantial reimbursement. However, in 2008 the National Association of Spine Surgeons recommended that the system’s code be changed to Category III due to a lack of safety and efficacy data. The AMA adopted the NASS recommendation effective January 1, 2009, requiring the system to be coded under Category III from that date.

Appellants Phillip J. Singer and others similarly situated are a putative class of investors in TranS1 during a period in which, according to their complaint, the company and its officers engaged in a fraudulent reimbursement scheme that was concealed from the market. Specifically, the Plaintiffs allege that TranS1 encouraged and coached surgeons to engage in improper reimbursement practices in direct violation of various statutes by utilizing alternate codes that would allow for reimbursement. This practice, according the complaint, created an acute risk that TranS1 would be subject to legal action and scrutiny by the Department of Health and Human Services and other regulatory bodies.

The district court granted the Defendants’ motion to dismiss the complaint, on grounds that, although the Plaintiffs adequately alleged the loss-causation element of their § 10(b) claim, they had not sufficiently pled the material-misrepresentation or scienter elements. The Plaintiffs appealed, contesting the district court’s rulings as to the material-misrepresentation and scienter elements; the Defendants cross-appealed, challenging the district court’s ruling on the loss-causation element.

Material misrepresentation

Contrary to the district court’s ruling, Singer’s complaint sufficiently pleads material misrepresentation by specifying a series of statements alleged to have been misleading, because of both what was falsely said and what was deceptively omitted. By those statements – made by TranS1’s officers in SEC filings, press releases, and conference calls – the company acknowledged the new Category III code for the system and efforts to eventually return to a Category I code. But at the same time, TranS1 misrepresented the assistance and training it was providing to surgeons as being wholly for the attainment of “appropriate” reimbursements for the system. TranS1 also misrepresented that the Category III code was “not an experimental code.”

Meanwhile, TranS1 downplayed the financial consequences of the Category III code and suggested that losses would be insignificant and temporary. Throughout the officers’ statements, they omitted key facts: that TranS1 was coaching surgeons to improperly use a Category I code, rather than the mandatory Category III code, and was relying on that fraudulent reimbursement scheme to generate a substantial portion of TranS1’s continuing revenues. These allegations are sufficient to plead the material misrepresentation element of the § 10(b) claim, easily surviving a materiality analysis at the dismissal stage.

Furthermore, the complaint adequately alleges that TranS1 acted deceptively by way of misstatements and omissions by those with a duty to disclose. The Plaintiffs focus on the company’s repeated failure to divulge its fraudulent reimbursement scheme. Although neither § 10(b) nor SEC Rule 10b-5 create an affirmative duty to disclose any and all material information, disclosure is required when necessary to make statements not misleading in light of the circumstances in which they were made.

By choosing to inform the market that it was training surgeons on how to obtain reimbursement for the system in the wake of the AMA’s Category III coding requirement, TranS1 was obliged to further disclose its fraudulent reimbursement scheme, i.e. its instructions to surgeons to unlawfully use Category I. Otherwise, the officers’ statements about TranS1’s training efforts were utterly misleading. The same is true of their statements that the Category III code was causing only limited losses: By not disclosing the company’s fraudulent reimbursement scheme, the officers misled the market about the actual source of TranS1’s continuing revenues.

As such, the complaint alleges that TranS1 possessed – and breached – a duty to disclose the fraudulent reimbursement scheme. The company’s argument that the complaint explains no theory of illegality is unavailing. The duty to disclose may extend to uncharged and unadjudicated illegal conduct.

A reasonable investor would have considered the scheme important in deciding whether to buy or sell TranS1 stock and would have viewed the total mix of information made available to be significantly altered by the scheme’s disclosure. Accordingly, the complaint adequately alleges a material misrepresentation for purposes of § 10(b).


The Plaintiffs have also sufficiently pled the scienter element of their § 10(b) claim. The complaint reflects that the illegality of the fraudulent reimbursement scheme was obvious and known to TranS1’s officers. The company publicly acknowledged the Category III code and related reimbursement issues, and the law was clear that only the Category III code could be used. The company’s officers spoke in detail about their legal strategies to deal with the new Category III code, without ever mentioning TranS1’s illegal efforts to persuade surgeons to use a Category I code instead. If the officers believed that the system could still lawfully be coded under Category I, it certainly would have said so. These recurring omissions are particularly remarkable because the undisclosed scheme was the primary source of TranS1’s continuing revenues, while the strategies discussed in the officers’ various statements generated far less significant returns.

By alleging that the fraudulent reimbursement scheme was known to the officers, clearly illegal, and fundamental to TranS1’s financial success, the complaint establishes that the officers’ failure to disclose the scheme presented a danger of misleading Singer and other investors – a danger that was also known to the officers, or so obvious that the officers must have been aware of it.

Loss causation

The district court correctly concluded that the complaint sufficiently pleads the loss-causation element of its § 10(b) claim, alleging a direct relationship between the plaintiff’s economic loss and the defendant’s fraudulent conduct. Here, the complaint demonstrates exposure of TranS1’s misrepresentation by way of an amalgam of the materialization-of-concealed-risk and corrective-disclosure theories.

To satisfy the loss-causation element, the Plaintiffs rely on a partial corrective disclosure by the company, coupled with news from another source (an analyst report). At the time, the market already knew from the officers’ public statements that the system’s appropriate coding had changed to Category III and, thus, was largely non-reimbursable. The market also knew of TranS1’s lawful efforts to return to Category I.

Together, the corrective disclosure and the analyst report revealed the following additional facts: that TranS1 had received a subpoena “under the authority of the federal healthcare fraud and false claims statutes”; that the subpoena sought items including reimbursement communications with physicians; and that, despite the system’s nearly three-year-old Category III coding requirement, approximately half of TranS1’s revenues were still coming from physicians still using a Category I code.

These facts together revealed what the officers’ previous statements had materially omitted: the existence of the company’s fraudulent reimbursement scheme. Indeed, the analyst report surmised from these facts, with radar precision, that the subpoena related to TranS1’s illicit reimbursement communications. Thus, they were sufficient to establish exposure for purposes of the loss-causation element because they collectively suggest that the company perpetrated a fraud on the market.

Consequently, the district court’s rulings dismissing the § 10(b) claim are vacated. However, the district court’s ruling as to loss-causation is affirmed.


(Agee, J.) The majority’s holding impermissibly expands the scope of liability under § 10(b) and elides our Rule 12(b)(6) and Private Securities Litigation Reform Act jurisprudence. Singer failed to properly plead the elements of material misrepresentation or omission, scienter, and loss causation as required by Rule 8 and Rule 9(b). Any one of those failures undermines his claim, and here Singer flunks all three. Despite his failure to show loss causation related to a decline in TranS1’s stock price that was caused by a false statement or omission made with scienter, Singer will be allowed to go on to discovery – and to tax the district court and Defendants’ valuable time and resources. I would affirm the judgment of the district court dismissing this case on the scienter and misrepresentation or omission arguments, and reverse on its finding that loss causation was adequately pled.

Singer v. Reali (Lawyers Weekly No. 001-034-18, 64 pp.) (King, J.) Nos. 15-2579 and 16-1019; Feb. 22, 2018; EDNC at Wilmington (Fox, J.) Jeremy Alan Lieberman for Appellant; Stephen L. Ram and Aaron C. Humes for Appellees. 4th Cir.


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